- 11 Marks
MA – Nov 2020 – L2 – Q4a – Discounted Cash Flow
Calculate the cost of capital to break-even for a van investment over five years and discuss the advantages and disadvantages of the payback method.
Question
a) Jayjay & Co is a medium-sized company that is engaged in delivery services. As a result of the recent increase in the demand for its services, the Managing Director (MD) is planning to acquire a delivery van at the cost of GH¢85,000. The expected net cash flow per year is as follows:
| Year | Net Cash Flow (GH¢) |
|---|---|
| 1 | 25,000 |
| 2 | 28,000 |
| 3 | 39,000 |
| 4 | 34,000 |
| 5 | 24,000 |
The Sales Manager has indicated to the MD that the company will recoup its investment in less than four years, and for that reason, it’s a good investment. The Management Accountant, however, has drawn the MD’s attention to the fact that the Sales Manager has not factored in the time value of money and the cost of capital into his analysis.
Required:
i) Calculate the cost of capital that, when used, will make the investment break-even when the useful life of the van is five years with a residual value of GH¢8,500.
ii) Explain TWO (2) advantages and TWO (2) disadvantages of the payback method of investment appraisal and show how it compares to the discounted cash flow method.
Find Related Questions by Tags, levels, etc.
- Tags: Capital Budgeting, Cost of Capital, Investment Appraisal, Payback Method
- Level: Level 2
- Topic: Discounted cash flow
- Series: NOV 2020