(B)Alternatively, the financial director of (STS) Limited is proposing to use 40% the total capital outlay for the above investment to repurchase some of the equity capital and the remaining funds to pay for cash dividends.
Ensuring the response draws upon relevant academic research within this highly topical area of financial management, critically evaluate the effects of this proposal on the company. (10 marks)
The NPV is negative as (£17,406.1) when cost of capital is 13%. If company accept this protect their valve will decrease and shareholders wealth will decrease.
(C) Critically evaluate the benefits and limitations of each of the differing investment appraisal techniques, ensuring the use of relevant academic literature. (20 marks)
Payback period
Payback period is the simplest investment appraisal techniques. Payback period technique shows how long time the project will be taken to provide the sufficient cash-flow to cover the initial cost of the project.
It is easy to understand and calculate, it provides a direct view on how long it will take to cover an investment and it helps to identify the time of the cash flow become positive on the project and it provide less risk.
However, it did not consider the interest (time value). It will ignore some protect need longer term to get higher payback, and all cash flows after the payback period.
Accounting Rate of Return (ARR)
Accounting Rate of Return (ARR) measures the profit expected from an investment. It counts the net accounting profit returning from the investment and make it shows as a percentage of that capital investment.
It is also an effortless way to understand and calculate. It will provide how much the profits earned over the entire time of the project but it does not consider the timing of the cash flow because it uses the average data, so it does not show the time value of the money.
Net Present Value (NPV)
Net Present Value (NPV) is the sum of discounted cash outflow and inflow in the future related to the project. It is the most common method of investment appraisal.
It considers the time value of money and helps to determine profitability of projects using cash flows rather than profits, so NPV can show the true situation of the cash flow of a project better than Payback period and ARR. However, it fails to consider the timings of cash flow and interest may change.
Internal Rate of Return (IRR)
Internal Rate of Return (IRR) is the discounting rate at which the company will make a loss or a profit. It is most simple to understand because it shows as a percentage and it considers the time value of money as well. But it does not consider the risk and other defined factors will involve in the project. And the concept of IRR is difficult to understand.
