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Flashcards · YAC11 · A Level Topic 2.6

Project appraisal (A Level) flashcards

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Topic 2.6: Project appraisal

Discount factor for year 2 at 8%, to 3 decimal places
1 ÷ 1.08² = 0.857.
Outlay 72,000; equal net cash inflows of 16,000 a year. Payback?
72,000 ÷ 16,000 = 4.5 years (4 years 6 months).
Equity provides 60% of finance at 11%; loans 40% at 6%. WACC?
0.6 × 11% + 0.4 × 6% = 6.6% + 2.4% = 9.0%.
Profitability index: formula and decision rule. PV of inflows 138,000, outlay 120,000?
PI = PV of future inflows ÷ initial investment = 138,000 ÷ 120,000 = 1.15. Accept when PI > 1.
Outlay 50,000; 30,000 at the end of each of the next 2 years; factors 0.926 and 0.857. NPV?
27,780 + 25,710 = 53,490. NPV = 53,490 − 50,000 = +3,490: accept.
NPV is +6,000 at 12% and −2,000 at 20%. Estimate the IRR
12 + [6,000 ÷ (6,000 + 2,000)] × 8 = 12 + 6 = 18%. Accept if IRR is above WACC.
Average annual profit 9,000; cost 60,000; residual value 12,000. ARR on initial and on average investment?
Initial: 9,000 ÷ 60,000 = 15%. Average investment (60,000 + 12,000) ÷ 2 = 36,000: 9,000 ÷ 36,000 = 25%.
NPV and IRR rank two mutually exclusive projects differently. Which is preferred?
NPV, because it measures the size of the gain in money terms at the business's cost of capital.
Time value of money: why is money received sooner worth more?
It can be reinvested, it is not eroded by inflation, and it carries less risk.
Which appraisal method charges depreciation, and which ignore the time value of money?
Only ARR charges depreciation, because it uses profit. ARR and payback ignore the time value of money; NPV, PI and IRR allow for it.

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