Capital investment appraisal (A Level) flashcards

Topic 13: Capital investment appraisal

Which of these are left out of the cash flow schedule: depreciation, sunk costs, unchanged shared overheads, interest on finance?

All four. Depreciation is not cash, sunk costs are already spent, unchanged overheads happen anyway, and the cost of capital already covers interest.

Outlay $20,000; inflows $9,000, $9,000 and $7,000. Payback?

Cumulative (11,000) then (2,000) after year 2. 2 years + (2,000 ÷ 7,000) × 12 = 3.4 months: 2 years 3 months.

Same project at 5%, factors 0.952, 0.907, 0.864. NPV?

PVs 8,568 + 8,163 + 6,048 = $22,779. NPV $2,779 positive: acceptable on financial grounds.

A $45,000 kiln brings $13,500 a year for 4 years and is sold for $5,000 at the end. Payback, and the year 4 NPV cash flow?

Payback 45,000 ÷ 13,500 = 3⅓ years: 3 years 4 months. Year 4 cash flow 13,500 + 5,000 = $18,500 (residual value added before discounting).

A new oven costs $40,000 and the old oven is sold now for $3,000. Year-0 net cash flow?

40,000 − 3,000 = ($37,000). The sale of a replaced asset reduces the outlay.

Cumulative cash flow is ($9,000) at the end of year 2; year 3 inflow is $27,000. Payback?

9,000 ÷ 27,000 × 12 = 4 months: 2 years 4 months.

Year-1 discount factor at 12%, and the year-0 factor

1 ÷ 1.12 = 0.893. Year 0 factor is 1.000.

Cost of capital vs discount factor

The cost of capital is a percentage: the return lenders and owners require. The discount factor is the multiplier calculated from it for a particular year.

Payback and NPV: one strength and one weakness each

Payback: simple and protects liquidity; ignores the time value of money and cash after payback. NPV: allows for the time value of money and uses all cash flows; depends on the cost of capital chosen and says nothing about speed of recovery.

Can undiscounted inflows exceed the outlay and still give a negative NPV?

Yes. Discounting reduces later inflows, so their present values can total less than the outlay.