Answer to Question #309286 in Accounting for Queen

Question

AIT construction Company is into the establishment of theater halls for cinematograph is considering purchasing equipment that costs Ghc23,000. The equipment has an estimated useful life of 5 years and no salvage value. B Company believes that the annual cash inflows from using the equipment will be Ghc65,000.

Required:

i. Calculate the net present value of the equipment assuming that B Company's cost of capital is 10%. Is the equipment an acceptable investment?

ii. Calculate the net present value of the equipment assuming that B Company's cost of capital is 12%. Is the equipment an acceptable investment?

iii. Explain the use of payback period and what are the flaws of the method as compared to NPV method of evaluating cash flows.

Answer 1

i., ii calculate in EXCEL

NPV is greater than zero, then such a project is recognized as economically profitable.

iii.A significant drawback of this indicator, as a criterion for the attractiveness of the project, is that it ignores the positive values of the cash flow that go beyond the calculated period.

Also, this method does not distinguish between projects with the same PP value, but with a different distribution of income within the calculated period. Thus, the principle of the time value of money is partially ignored when choosing the most preferred project.