Harding Case Stuy

GROUP ASSIGNMENT – ANSWERS (AMIR FARID AZMAN)

Question 1

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Payback period for:-

1. Nano Test Tubes = Almost 3 years (2.75 years)
2. Microsurgery Kit = More than 3 years (3.4 years)

1. The rationale behind the payback method is to identify the period of time required to recover the funds expended in the investment. In this case, from the two proposals presented, by virtue of this method only, it seems that that Nano Test Tubes is more attractive.
2. The decision rule for the payback method are as follow:

If payback period < the minimum payback, ACCEPT the project

If payback period > the minimum payback, REJECT the project

The shorter the payback period of a project, the more attractive the project will be to management. In addition, management typically establishes a maximum payback period that a potential project must meet.

1. The general rule to rank mutually exclusive projects is as follow:

If payback period for project A < project B => Choose project A

When two projects are compared, the project that meets the maximum payback period and has the shortest payback period is the project to be accepted. It is a simplistic measure, not taking into account the time value of money, but it is a good measure of a project's riskiness.

1. The advantages of payback method:

• It’s quick and easy to apply
• Serve as a rough screening device, identify attractiveness of a project from a surface point of view
• Provides some information on the risk of the investment
• Provides a crude measure of liquidity

The shortcomings of this method:

• Ignore the time value of money
• Ignore the cash flow after the payback period
• Ignore profitability of the project
• Ignores the risk of the future cash flow
• No concrete decision criteria to indicate whether the investment increases the company’s value

Question 2