Question 3 Simpson Ltd is an engineering company and is currently considering whether to accept one of the two mutually exclusive investment projects, namely project Bart and project Liza. The following are the Net Cash Flows of these two projects: Year Initial Investment 1 123 4 5 6 Project Bart £ (525,000) 260,000 (50,000) 302,000 240,000 194,000 125,000 Project Lisa £ (330,000) 80,000 162,000 180,000 145,000 81,000 a) Calculate the payback period for both projects and suggest which project (if any) is worthwhile if it is the company's policy not to take on a project with a payback period longer than 3 years. b) Briefly discuss the main reasons why, despite its numerous drawbacks, payback still remains a widely used technique for investment appraisal. c) Calculate the Net Present Value (NPV) for project Bart and project Lisa and recommend which project the company should invest in (if any), giving your reasons. The cost of capital is 10%. d) You are told that at a cost of capital of 28%, the NPV of Project Bart is -£34,109 and the NPV of Project Lisa is -£5,204. Use this information (and the answers to part (c)) to estimate the Internal Rate of Return (IRR) for both projects and explain how Simpson Ltd should interpret these findings.
Net Present Value
Net present value is the most important concept of finance. It is used to evaluate the investment and financing decisions that involve cash flows occurring over multiple periods. The difference between the present value of cash inflow and cash outflow is termed as net present value (NPV). It is used for capital budgeting and investment planning. It is also used to compare similar investment alternatives.
Investment Decision
The term investment refers to allocating money with the intention of getting positive returns in the future period. For example, an asset would be acquired with the motive of generating income by selling the asset when there is a price increase.
Factors That Complicate Capital Investment Analysis
Capital investment analysis is a way of the budgeting process that companies and the government use to evaluate the profitability of the investment that has been done for the long term. This can include the evaluation of fixed assets such as machinery, equipment, etc.
Capital Budgeting
Capital budgeting is a decision-making process whereby long-term investments is evaluated and selected based on whether such investment is worth pursuing in future or not. It plays an important role in financial decision-making as it impacts the profitability of the business in the long term. The benefits of capital budgeting may be in the form of increased revenue or reduction in cost. The capital budgeting decisions include replacing or rebuilding of the fixed assets, addition of an asset. These long-term investment decisions involve a large number of funds and are irreversible because the market for the second-hand asset may be difficult to find and will have an effect over long-time spam. A right decision can yield favorable returns on the other hand a wrong decision may have an effect on the sustainability of the firm. Capital budgeting helps businesses to understand risks that are involved in undertaking capital investment. It also enables them to choose the option which generates the best return by applying the various capital budgeting techniques.
Step by step
Solved in 3 steps with 2 images
