Financial Management Essay
a. Capital investment proposals can be evaluated from several methods such as: 1. Payback method: this method measures the time taken by the project in paying back the initial investment. The shorter the payback period the better the project. The formula to calculate payback period is: = (INITIAL INVESTMENT)/ (COST SAVINGS). In case of the two projects for Malaysian ABC, we would choose Project A because it has a shorter payback period. The rationale is that the project with a shorter duration is better because the shorter the duration, the less risky the project and the greater the liquidity is.
Advantages of payback period: * …show more content…
Other methods are Profitability Index and Accounting Rate of Return ARR. PI compares the present value of cash inflows with the present value of cash outflows, if the ratio is more than 1 the project is accepted else rejected and ARR measures profitability from the conventional accounting standpoint by relating the required investment to the future annual net income. Under the ARR method, the project with the higher rate of return is chosen
Evaluation of Two possible projects for Malaysian ABC Bhd | | | Project A | Amount in RM | | | | | Year | 0 | 1 | 2 | 3 | 4 | | | | | | | Initial Investment | -20000 | | | | | Cash flows | | 12500 | 6000 | 6000 | 2000 | Net cash flows | -20000 | 12500 | 6000 | 6000 | 2000 | PV factors @12% | 1 | 0.893 | 0.797 | 0.712 | 0.636 | Present value | -20000 | 11,160.71 | 4,783.16 | 4,270.68 | 1,271.04 | | | | | | | Payback period | 2 years and 3 months | | | | NPV | 1,485.60 | | | |