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1. Discuss the difference between – State also advantages & disadvantages each:

a. The payback period & the discounted payback period criteria of capital budgeting.

The payback period measures the time that it takes to recoup the cost of the investment. If the cash flows are an annuity, then we can simply divide the cost by the annual cash flow to determine the payback period Otherwise, as in the example, we subtract the cash flows from the cost until the remainder is zero The shorter the payback period, the better Generally, firms will have some maximum allowable payback period against which all investments are compared

Assume that your company is investigating a new labor-saving machine that will
May be useful when investment funds are limited.
Easy to understand and communicate
Correct decision when evaluating independent projects.

c. The IRR & the Modified IRR criteria of capital budgeting.

The internal rate of return (IRR) is the discount rate that equates the present value of the cash flows and the cost of the investment Usually, we cannot calculate the IRR directly, instead we must use a trial and error process For our example, the IRR is found by solving the following:

In this case, the solution is 13.45% Problems with IRR: The IRR is a popular technique primarily because it is a percentage which is easily compared to the WACC However, it suffers from a couple of flaws: • The calculation of the IRR implicitly assumes that the cash flows are reinvested at the IRR. This may not always be realistic. Percentages can be misleading (would you rather earn 100% on a \$100 investment, or 10% on a \$10,000 investment?)

Modified Internal Rate of Interest:

The modified IRR (MIRR) is the average