Essay Paper on Financial Management
Investments decisions are long run decisions where consumption and investment alternatives are balanced over time in the hope that investment now will generate extra returns in the future. There are similarities between short-run and long – run decision making, for example the choice between alternatives, the need to consider future costs and revenues and the importance of incremental changes in costs and revenues.On the other hand there is the additional requirement for investment decision that, because of the time scale involved, the value of the money invested must be considered. The time scale also makes the consideration of uncertainty and inflation of ever greater importance than when considering short-term decisions.
The methods used for evaluation of capital investments in practice have been the subject of a number of research studies over the last 20-30 years. The primary interest of researches has been to establish whether there is wide acceptance by decision makers of apparently superior methods, and to ask why methods other than those suggested by theory might be used in practice.
Two particular methods of comparing the attractiveness of competing projects have become known as the “traditional techniques”. There are the Accounting Rate of Return and Payback.
Payback is a popular technique for appraising projects either on its own or in conjunction with other methods. Accounting Rate of Return shown in the Table shows the ratio of average annual profits, after depreciation, to the capital invested. Here, Payback is a period expressed in years which it takes for the project’s net inflows to recoup the original investment.
This technique has some advantages and disadvantages which should be bear in mind by financial managers. The advantages include the following features: simple to calculate and understand; uses project cash flows rather than accounting profits and hence is more objectively based; favours quick return projects which may produce faster growth for the company and enhace liquidity. On the other hand it is possible to point out some disadvantages of the Payback method used in Table. The first, Payback described in the Table does not measure overall project worth because it does not consider cash flows after the payback period. Payback provides only a crude measure of the timing of project cash flows.
Using the data from Sumsung the profit figures first need to be adjusted to eliminate depreciation machine A cost $ 125 000. With a five year life and straight line depreciation, the annual depreciation is $25 000. For machine B , with the six year life, the depreciation is $20 000 per annum.
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