You have been appointed as chief management accountant of a well-established company with a brief to improve the quality of information supplied for management decision-making. As a first task you have decided to examine the system used for providing information for capital investment decisions. You find that discounted cash flow techniques are used but in a mechanical fashion with no apparent understanding of the figures produced. The most recent example of an investment appraisal produced by the accounting department showed a positive net present value of £35 000 for a five-year life project when discounted at 14 per cent which you are informed 'was the rate charged on the bank loan raised to finance the investment'. You note that the appraisal did not include any consideration of the effects of inflation nor was there any form of risk analysis.
You are required to:
(a) Explain the meaning of a positive net present value of £35 000; (4 marks)
(b) Comment on the appropriateness or otherwise of the discounting rate used; (4 marks)