| Investment Appraisal - Exercise 3.19 | Unnamed: 1 | Unnamed: 2 | Unnamed: 3 | Unnamed: 4 | SOLUTION |
|---|---|---|---|---|---|
| ARR Using the Original Equity Expenditure Method: | |||||
| Average Profit | x 100 | ||||
| Original Equity Expenditure | |||||
| Dept 1 | £30 / 5 Years | x 100 | |||
| 15 | |||||
| 0.4 | |||||
| Dept 2 | £20.5 / 5 Years | x 100 | |||
| 15 | |||||
| 0.24666666666666667 | |||||
| Using the Payback Method: | |||||
| Dept 1 | Year | Net Cash Inflows | Cumulative Net Cash Inflows | ||
| 1 | 6 | 6 | |||
| 2 | 8 | 14 | |||
| 3 | 8 | 22 | |||
| 4 | 9 | 31 | |||
| 5 | 12 | 43 | |||
| Payback Period = | 2 years + (6 / 8) x 365 days | ||||
| 2 years 274 days | |||||
| Dept 2 | Year | Net Cash Inflows | Cumulative Net Cash Inflows | ||
| 1 | 9.5 | 9.5 | |||
| 2 | 9 | 18.5 | |||
| 3 | 5 | 23.5 | |||
| 4 | 5 | 28.5 | |||
| 5 | 4.5 | 33 | |||
| Payback Period = | 2 years + (1.5 / 5) x 365 days | ||||
| 2 years 110 days | |||||
| Dept 2 would be successful. | |||||
| Dept 2 has a shorter payback period (164 days shorter). | |||||
| Shorter payback is less risky. | |||||
| Problem is that using Packback ignores the fact that the overall return on | |||||
| the original £20m is much higher with Dept1's proposal. |