Business Decision Making Sample Assignment (GC02230)
1.0 Introduction
2.0 Calculation of Payback Period and NPV for both projects
Payback period
It will give you the exact period to pay back Loan or financing, Difference between Cash inflows and Outflows is also outlined. It is not for very long financing, It doesn’t deal with the Time value of money so many times companies have to pay more than they actually acquire, Payback period has limitations with Inflation as well, the rise of inflation can cause serious damage to organization’s finance. Interest rates are also not entirely covered. However, we can calculate the interest rate over the payback period.
The payback period is the time taken to get back the investment. The payback period of the project 1 & 2 are shown here:
| Year | Net cash flow after 12% cost of capital
£ |
Cumulative cash flows
£ |
Net cash flow after 12% cost of capital
£ |
Cumulative cash flows £ |
| 0 | (40,000) | (40,000) | (60,000) | 60,000) |
| Year 1 | 7144 | (32856)
(-40,000+7144) |
8930 | (51070)
(-60,000 + 8930) |
| Year 2 | 9564 | (23292)
(-32856+9564) |
15940 | (35130)
(-51070+ 15940) |
| Year 3 | 11392 | (11900)
(-23292+11392) |
17800 | (17330)
(-35130+17800) |
| Year 4 | 12720 | 820
(-11900+12720) |
19080 | 1750
(-17330+19080) |
| Year 5 | 17010 | 17830 (820+17010) | 22680 | 24430
(1750+22680) |
| Year | Net cash flow after 12% cost of capital
£ |
Cumulative cash flows £ |
| 0 | (60,000) | 60,000) |
| Year 1 | 8930 | (51070)
(-60,000 + 8930) |
| Year 2 | 15940 | (35130)
(-51070+ 15940) |
| Year 3 | 17800 | (17330)
(-35130+17800) |
| Year 4 | 19080 | 1750
(-17330+19080) |
| Year 5 | 22680 | 24430
(1750+22680) |
NPV
NPV is essential for the financial appraisal of long-term projects, it measures the excess or shortfall of cash flows, In the NPV model, it is assumed to be reinvested at the discount rate used. This is appropriate in the absence of capital rationing. Yes it does have some disadvantages like adjustment for risk by adding a premium to the discount rate thus making cost higher, 2nd is compounding of Risk Premium, Now we all know that Risk premium is composite of Risk-free rate, Such compounding results in very low NPV…………..
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