Discuss Net Present Value (NPV) Payback has certain...

INVESTMENT APPRAISAL Characteristically, a decision to invest in a capital project involves a largely irreversible commitment of resources that is generally subject to a significant degree of risk. Such decisions have far-reaching effects on a companys profitability and flexibility over the long term, thus requiring that they be part of a carefully developed strategy that is based on reliable appraisal and forecasting procedures. In order to handle these decisions, firms have to make an assessment of the size of the outflows and inflows of funds, the life span of the investment, the degree of risk attached and the cost of obtaining funds. One of the most important steps in the capital budgeting cycle is working out if the benefits of†¦show more content†¦But this WACC can change and can be subject to disagreement. The NPV calculation is only valid for the interest rate that has been used. If an organisation has appraised its capital investment proposals using an interest rate of 14% it will have a series of go or no go decisions which will only be valid for an interest rate of 14%. If the interest rate rises to 15% or falls to 13%, the decisions will no longer be valid, the calculations will have to be re-worked and new decisions taken. PAYBACK The payback period is the most widely used technique and is literally the amount of time required for the cash inflows from a capital investment project to equal the cash outflows. The usual way that firms deal with deciding between two or more competing projects is to accept the project that has the shortest payback period. Payback is often used as an initial screening method. Payback period = Initial payment / Annual cash inflow So if 4 million Euro is invested with the aim of earning 500.000 per year (net cash earnings), the payback period is calculated thus: P =Show MoreRelatedCapital Budgeting5568 Words   |  23 PagesCAPITAL BUDGETING MEANING OF CAPITAL BUDGETING Capital budgeting is the making of long term planning decision for investment fixed assets and their financing. Capital budgeting decision is concerned with current investment that will pay for itself and yield an acceptable rate of return over its life span. Hampton (1992) defines capital budgeting as the decision making process by which firms evaluate the purchase of major fixed assets, including buildings, equipment. 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