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Submitted By felizpesalgueiro

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Words 1395

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Question A Yes, because all entities would find it difficult to survive if they did not invest in some form of capital expenditure from time to time and they certainly would not be able to grow and to develop. In capital investment appraisal it is the role of directing attention which is important. Investment appraisal will add value to the business entity because it assists management decision making by providing information on the investment in a project and the benefits to be obtained from that project and by monitoring the performance of the project subsequent to its implementation.

Question B

Project A: £000 Year NCF 1 22 2 31 3 43 4 52 5 71 Cumulative NCF 22 53 96 148 219

Payback = 3 + 125-96/52 Payback = 3 + 0.56 Payback = 3.56 years = 3 years 6,7 months

Project B: £000 Year NCF 1 43 2 43 3 43 4 43 5 43

Cumulative NCF 43 86 129 172 215

Payback = 2 + 125-86/43 Payback = 2 + 0.91 Payback = 2.91 years = 2 years 10.9 months

Imposing a 3 years maximum payback period, AP Ltd should accept the project B with 2.91 years of payback.

Question C The payback method neglects both cash flows after the payback period and the time value of money. It has others disadvantages, these are follows: • There is a risk that projects with the shortest payback periods may be chosen even if they are not as profitable as projects with a longer payback period

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because this method only measures cash flows; it does not measure profitability. • • • The total amount of the overall investment is ignored and comparisons made between different projects may result in misleading conclusions. It is difficult to calculate the net cash flows and the period in which they will be received. The timing of the cash flows is not taken into account. There is clearly less risk in accepting a project that recovers most of its cost…...

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