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Financial Management Week 6 (evaluation method (Accounting Rate of Return…
Financial Management Week 6
evaluation method
Accounting Rate of Return (ARR)
similar to return on asset ratio
ARR = Average aft tax accounting profit / average cost of investment
average cost of investment = (initial value - residual value)/2
advantages
disadvantages
not based on cash flow
dependence on depreciation charges
time value of money is ignored
not cater for risk
Payback Period
how long to get money back
PP = Investment/NCF
advantages
simple to calculate
risk insight
supplementary information
disadvantage
no time value of money (discounted PP)
cut off period is subjective
cash flow after PP is not considered
Net Present Value (NPV)
Internal Rate of Return (IRR)
IRR > cost of capital: go ahead
IRR < cost of capital: NO GO
assumptions
the goal of financial management
competing opportunities
importance of investment decision
asset and risk
long period fund
working capital
resource commitment
future success
selection of project/investment
evaluation process