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Investment Appraisal
Learning ObjectivesDiscuss the difficulty of finding profitable projects in competitive markets and the importance of search.
Determine whether a new project should be accepted or rejected using the payback period, net present value, the profitability index, and the internal rate of return.
Explain how the capital-budgeting decision process changes when a limit is placed on the dollar size of the capital budget.
Discuss the problems encountered in project ranking.
Explain the importance of ethical considerations in capital-budgeting decisions.
Discuss the trends in the use of different capital-budgeting criteria.
Explain how foreign markets provide opportunities for finding new projects.

The process of decision making with respect to investments in fixed assets – that is, should a proposed project be accepted or rejected.
All of techniques attempt to compare the costs and benefits of a project.
The rule of capital budgeting is to accept all projects for which the cost is less than, or equal to, the benefit: Accept if: Cost £ Benefit; Reject if: Cost > Benefit
Within the Firm: Typically, a firm has a research & development (R&D) department that searches for ways of improving existing products or finding new projects.
Other sources: Competition, Suppliers, Customers
Capital-Budgeting Decision CriteriaPayback Period
Accounting Rate of Return
Net Present Value
Profitability Index
Internal Rate of Return
Capital Rationing
Number of years needed to recover the initial cash outlay of a capital-budgeting project
Decision Rule: Project feasible or desirable if the payback period is less than or equal to the firm’s maximum desired payback period.
Example: Project with an initial cash outlay of $20,000 with following free cash flows for 5 years.
Benefits:
Uses cash flows rather than accounting profits
Easy to compute and understand
Useful for firms that have capital constraints

Drawbacks:
Ignores the time value of money and
Does not consider cash flows beyond the payback period.

DPP is exactly the same as the regular payback period, except that we use the present values of the cash flows in the calculation
Example: Should we buy the following machine using DPP, given the cash flows as below and the required return of 12%

NPV is better than both PP and ARR because:
NPV considers the time value of money or timing of cash flows by using discount factors. Discounted cash flow implies taking opportunity cost of capital into account.
NPV treats each cash flow of a specific year differently using different discounting factors. All cash flows are interdependent in affecting NPV and are taken into consideration.
NPV is in line with the objective of the business: NPV>0 increases shareholder wealth
All relevant and measurable financial information related to decision is exploited in calculating NPV.

   The main problem of IRR: it does not emphasise wealth maximisation
   IRR does not consider the scale of the investment.
   IRR’s focus is only the rate comparison.
   NPV is more reliable than IRR.
Each appraisal method has shortcomings:
The problem with NPV:
it is assumed that expected future ca本论文由英语论文网提供整理，提供论文代写，英语论文代写，代写论文，代写英语论文，代写留学生论文，代写英文论文，留学生论文代写相关核心关键词搜索。