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Investment Appraisal (Payback)
Home Level 2 2.4 Financial Management Archive by Category "Investment Appraisal (Payback)"

Category: Investment Appraisal (Payback)

2.4 Financial ManagementInvestment Appraisal (Payback)Level 2

May 2019 Q3 a(iv)

ASANTA Ghana Ltd is considering investing in the following projects which are considered mutually exclusive:

ASANTA Ghana Ltd uses the straight line method of depreciation. However, tax-allowable depreciation is 30% on straight line basis. The cost of capital for the company is 20% per annum.

(Note: Advise the Company on which of the projects to implement or undertake.)

Required:
Compute the Payback period for each project.                                                                                          (3 marks)

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Decision:  Project GO gives the lowest payback period and should be selected.

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2.4 Financial ManagementInvestment Appraisal (Payback)Level 2

May 2017 Q3 a.

Payback method refers to the period of time it takes for the cash flows to cover the initial cost of investment or recoup the initial cost of investment. The period is usually calculated in years.
Required:
Identify TWO advantages and TWO disadvantages of using the payback method in investment appraisal?                   (4 marks)

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Advantages:

  • Simple and easy to use.
  • It gives indication of the liquidity. The earlier the payback period the better the liquidity.
  • It broadly measures the risk of the project. The earlier the payback period the better the risk.
  • Is faster to compute

Disadvantages:

  • It ignores the time value of money.
  • Ignores the cash flows after the payback period and may discriminate against projects that have significant cash flows after the payback period.
  • It ignores the residual value and total economic life of the project.
  • Determination of the payback period upfront could be subjective and discretionary.
  • It measures mainly recovery of capital and not profitability of the project.

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