Notes

1. What should the decision seek to achieve of the manager who

is making decisions involving capital investments?
Investment decisions must be consistent with the objective of the
business. For a private sector business, maximizing the wealth of
the owner is key financial objective.
2. Research shows that there are four methods used in practise
by business throughout the world to evaluate investment
opportunities.
a)ARR accounting rate of return, Payback period, NPV and IRR
ARR Method says:
The amount of profit, or return, that an individual can expect based
on an investment made. Accounting rate of return divides the
average profit by the initial investment in order to get the ratio or
return that can be expected
=(avg annual operating profit/average investment to earn that
profit) *100%
avg annual operating profit = avg profit of 5 years depreciation
average investment = (initial investment + disposal value)/2
Higher the better
ARR problem is that it ignores the time factor. Hurdle rate is the
minimum rate that a company expects to earn when investing in a
project
Another problem is that ARR uses accounting profits rather than
actual cash flows
b) Pay Back Period: Measures the time it takes the business to
recoup its investment. 24000 is the saving on electric bill and cost
of solar panel is 90,000. So the annual saving is 24000 hence it will

take 3.75 years to recoup that 90,000 so 3.75 is the pay back
period. JOO REH GAYA HAI AMOUNT THAT BECOMES
NUMERATOR AND AYAA BECOMES DENOMINATOR PLUS 2
2 problems in this pay back periods are that it ignores time value of
money and profits after pay back period.
c) NPV Net Present Value
Three reasons why a 100 now is not equal to 100 in years time:
Interest lost
Risk
Inflation (loss in the purchasing power)
Summary of PV is = the example that I did in my mind of 20,000
and 16667 with 20% (also refer to excel sheet for table concept)
If the npv is positive the project should be selected and if we have
to choose from two npvs then choose the higher one
Lets say if the npv of a particular project is 25 and initial cost is 100
then the maximum the business should pay for this project is 125
However if npv is -25 then the business can pay initial cost upto 75
but not 100
d) IRR https://www.youtube.com/watch?v=7w-UWuDi0fY the higher
the better