Solutions to review questions 13.1 In essence, the discounted cash-flow method calculates the cash inflows and outflows of a project, as if they occurred at a single point in time so that they can be aggregated added, subtracted, etc) in an appropriate way and then can be compared to cash flows from other projects. 13.2 No. Only quantitative outcomes are formally analysed in capital-budgeting decisions. Many effects of capital-budgeting decisions, however, are difficult to quantify in financial terms. These non-financial or qualitative factors, for example, the number of accidents in a manufacturing plant or employee morale, are important to consider in making capital-budgeting decisions. 13.3 The payback method measures the time it will take to recoup, in the form of net cash inflows, the total amount invested in a project. The payback method is simple and easy to understand. It is a handy method when precision in estimates of profitability is not crucial and when predicted cash flows in later years are highly uncertain. The main weakness of the payback method is its neglect of profitability and the time value of money. 13.4 There are many different ways to calculate the accounting rate of return (ARR. One way frequently used is Increase in expected average annual operating income ARR Net initial investment The strengths of the ARR method are that it is simple, easy to understand and considers profitability. Its weakness is that it ignores the time value of money.
