Capital Expenditure Valuation Methods

1130 Words Oct 12th, 2013 5 Pages
Capital Expenditure Valuation Methods The payback period is the time it takes for a project or investments cash outflows to be recovered by cash inflows generated from the same project or investment. It is a very simple and commonly used capital budgeting technique. The formula used to compute the payback period is initial investment divided by cash inflow per period. You generally want to choose the investment that provides the shortest payback period, because you will get you cash back and it can be put toward other investments or projects. The longer the payback period the riskier it is. Top management will normally have a target payback period. They should select the project that offers a payback period less than the target. There …show more content…
The project with the highest value should be accepted. Although, the internal rate of return method is quite accurate, it does have some disadvantages. When uneven cash flows are involved, the interactive process is inconvenient and time consuming. Also, if there are fractional interest rates and a present value table doesn’t account for this then the internal rate of return will be difficult to determine. In some instances, certain projects may have several rates of return that will make the net present value of cash flows to equal zero. The modified internal rate of return is also the discount rate at which the net present value of an investment equal zero, but it is an improved version of the internal rate of return as it does not require the assumption that project cash flows are reinvested as the internal rate of return but it determines a reinvestment rate. If the modified internal rate of return is greater than the project’s hurdle rate, which is the rate of return specified as the lowest acceptable return on investment, then the project should be accepted. If choosing between several projects, the one with the highest rate would be the best option. The advantage of the modified internal rate of return is that it solves some of the problems associated with the regular internal rate of return. The modified rate of return considers that funds reinvested are going
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