Objectives:
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To understand and calculate a simple cash flow
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To understand payback periods
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To understand and calculate net present values
Calculating net present values
Often the hardest part of investment appraisal is to arrive at an accurate cash flow. For Shinkendo much of the information is informed guesswork.
Cash flows
In order to calculate any investment appraisal you need to set out the projected
cash flow. To keep things simple at this level of study let us assume that:
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all capital investment will be made immediately and the project is given the go ahead by the board of directors; it will happen in year 1
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all profit flows are in cash
Using calculations you have made as you have gone through the exercises so far you should be able to determine if the sums generated will cover the initial development costs. Thinking back to the environmental facts should they be using the development costs quoted by DA or is there a need to outsource that development? Can they meet the required 20% discount rate without outsourcing, expanding the market, or seeking sponsorship from sporting bodies?
Payback
Any investment in a new piece of machinery or a new product development is a
risk. Management try to manage risk within limits with which they are
comfortable. Management are responsible to the shareholders, therefore they
should be prudent in the level of risk they are willing to take. Acceptable
levels of risk vary from business to business.
Payback is one measure of risk. The sooner a project can repay its initial
investment then the lower the risk. This can be illustrated by the simple
example of your friend promising to pay you £10 now or £10 in a year's time. Do
you think your friend will really pay you in a year's time?
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