Exhibit 2: Cash flow Estimates of three (3) of the firms recent projects Life Initial Investment Cash
Question:
Exhibit 2: Cash flow Estimates of three (3) of the firm’s recent projects
Life | Initial Investment | Cash Inflow | |
X | 5 | £386,400 | £120,000 |
Y | 10 | £519,200 | £120,000 |
Z | 15 | £609,000 | £120,000 |
Required: A2 The company uses the payback period and accounting rate of return methods to appraise its project; the simplicity of these methods is attractive to management. You recently come across a study suggesting that similar companies as Abby Plc. use more sophisticated methods based on time value of money. You believe that a more reliable project appraisal could be made using any of the discounted cash flow methods. It is difficult to calculate the firm’s cost of capital but similar companies typically require a minimum return of 10% on equity finance. Abby Plc. is an all-equity financed firm.
Required
- Prepare a second report to management on its investment appraisal options. Your report should include:
- (A2i) A discussion of discounted cash flow methodologies and their assumptions.
- (A2ii) A quantitative analysis of each of the projects above using any two (2) discounted cash flow methods. (Also discuss the implications of your figures).
- (A2iii) A brief section discussing the treatments of working capital, scrap value, depreciation, taxes, capital rationing, unequal project lives, and inflation in investment appraisal.
- A3 Discuss why and how the choice of investment appraisal method and cost driver may partly explain a firm’s reported performance.
Expert Answer:
A2i Discounted cash flow techniquestime adjusted cash inflow technique Pay back method and average rate of return ARR method do not consider the time value of money The initial amount incurred for acq... View the full answer
