Question & Answer: Students are expected to cover THREE of the following: Payback analysis: this assesses the time period…

Students are expected to cover THREE of the following: Payback analysis: this assesses the time period that is required to pay back’ the initial investment. The method works by evaluating the inflows of funds, such as me increased profits that can be achieved from the investment and netting these inflows against the expenditures made. The effect of using me payback criterion is that it gives preference to projects which pay back quickly, even if other projects offer better returns in the long term. The average rate of return: This is another relatively simple method to evaluate investment decisions and calculates the average rate of return earned by the money invested. The drawback of the ARR method is that it takes no account of the timing of cash flows. Later cash flows are more speculative than earlier ones, but all are given equal weight in the ARR calculation. Net present value: In this method, the estimated net cash flows for each year are estimated and the appropriate discount factor is applied to calculate the present values of all cash flows over the life of the projects. By to telling these, it is possible to arrive at the net present value (NPV) of the project. A positive NPV will mean that the project will earn a higher level of Interest or return than the chosen discount rate. Internal rate of return: The discount rate at which a zero NPV occurs is called the internal rate of return (IRR) of a project. Effectively, this rate can be used as a way of deciding for or against an investment project. Under this method, the higher a project’s internal rate of return, the more desirable It is to undertake the project. As such, IRR can be used to rank several prospective projects a firm is considering. Assuming all other factors are equal among the various projects, the project with the highest IRR would probably be considered the best and undertaken first. Higher marks will be awarded to students that provide comprehensive answers that assess the three methods of investment appraisal sough, by the question. UP to 8 marks for an assessment of each form of investment appraisal and demonstrating an understanding of the role and importance of investment appraisal in the context of building a new Electrical Engineering facility.

Expert Answer

Payback analysis is the time in which we get our actual investment back after investing in a project. We have to calculate the total investment we put and compare it with the sales we got and the extra amount we got other than our investment which is profit. This method helps us to invest wisely in projects where we get our money back quickly which is very profitable.The average rate of return is the method of calculating the average amount which is set to return from our investment. But the major drawback of this method is it does not take time taken into consideration. Net present value helps to determine the amount currently available , so that we could set the discount rates which further leads us to earn more interest than a chosen discount rate. The amount at which this discount rate becomes zero is called Internal rate of return. This is the key point which helps us to decide whether to invest in a project or not. The more the IRR , the best is the project.

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