Net Present Value ( Npv )

The payback period looks at a project only until the costs have been recovered. This analysis tool is often ignored because it does not take into consideration the time value of money. The time value of money limitation of the payback period can be modified by using the discounted cash flows of a project for the analysis of when the outflows will be recovered.

NPV analysis uses future cash flows to estimate the value that a project could add to a firm’s shareholders. A company director or shareholders can be clearly provided the present value of a long-term project by this approach. By estimating a project’s NPV, we can see whether the project is profitable. Despite NPV analysis is only based on financial aspects and it ignore non-financial information such as brand loyalty, brand goodwill and other intangible assets, NPV analysis is still the most popular way evaluate a project by companies.

IRR uses all cash flows and incorporates the time value of money. When evaluating independent projects, IRR will always lead to the same decision as NPV. Because IRR assumes that cash flows will be reinvested at the internal rate of return, which is not always or even usually the case, it can rank mutually exclusive projects incorrectly. With certain patterns of cash flows, the IRR equation has more than one solution, which confuses the decision rule. IRR is slightly more

EEC calculated the amount of time involved the anticipation of its cost ($3 million). The timeline in recovering their cost of investment ($2 million) initially for the foundation of this investment any profit made in the future of this investment will be justified as a profit for the company. If EEC can anticipate a fast return on its investment it is a profitable wise decision in making the investment financial, it is considered to be an easier way of formulating investments financially. On the basis of one year all cash flows is added together equal to the sum of $2 million originally invested, then it is divided by the annual cash flow of $500,000. The calculation of the payback period would equal four years. After this time frame any financial proceeds will be considered profitable for the company. I conclude that the timeframe is adequate in comparison of the investment in this worthwhile investment financial venture for the company.

In real live project with more cash flow after the pay back period would be more valuable than Project with no cash flow, yet its payback and discounted payback make it look worse. This is the reason, the shorter the payback period, other things held constant, the greater the project’s liquidity. Apart from this, since cash flows expected in the distant future are generally riskier than near-term cash flows, the payback is often used as an indicator of a project’s riskiness because the longer the payback period the higher is the risk associated with the project (Brigham, 2004) (Fabuzzi, 2003).

Account for time. Time is money. We prefer to receive cash sooner rather than later. Use net present value as a technique to summarize the quantitative attractiveness of the project. Quite simply, NPV can be interpreted as the amount by which the market

Net Present Value (NPV) calculates the sum of discounted future cash flows and subtracting that amount with the initial investment of the project. If the NPV of a project results in a positive number, the project should be undertaken. It is the most widely used method of capital budgeting. While discount rate used in NPV is typically the organization’s WACC, higher risk projects would not be factored in into the calculation. In this case, higher discount rate should be used. An example of this is when the project to be undertaken happens to be an international project where the country risk is high. Therefore, NPV is usually used to determine if a project will add value to the company. Another disadvantage of NPV method is that it is fairly complex compared to the other methods discussed earlier.

The ARR also fails to consider the timing of profit as a 22% ARR in 12 years may be better than a 18% rate of return for 8 years, ignoring that the longer the term of the project, the greater the risk involved.

D.) One defect of the IRR method is that it assumes that the cash flows to be received from a project can be reinvested at the IRR itself, and that assumption is often not valid.

The use of an accounting rate of return also underscores a project 's true future profitability because returns are calculated from accounting statements that list items at book or historical values and are, thus, backward-looking. According to the ARR, cash flows are positive due to the way the return has been tabulated with regard to returns on funds employed. The Payback Period technique also reflects that the project is positive and that initial expenses will be retrieved in approximately 7 years. However, the Payback method treats all cash flows as if they are received in the same period, i.e. cash flows in period 2 are treated the same as cash flows received in period 8. Clearly, it ignores the time value of money and is not the best method employed. Conversely, the IRR and NPV methods reflect that The Super Project is unattractive. IRR calculated is less then the 10% cost of capital (tax tabulated was 48%). NPV calculations were also negative. We accept the NPV method as the optimal capital budgeting technique and use its outcome to provide the overall evidence for our final decision on The Super Project. In this case IRR provided the same rejection result; therefore, it too proved its usefulness. Despite that, IRR is not the most favorable method because it can provide false results in the case where multiple negative

In fully investigating all of our calculations we are fully invested in using the Net Present Value figures we calculated as a means of ranking the eight projects. In doing so we found reasons in which why the Net Present Value was our benchmark for ranking the projects and why we did not use the Payback Method. The Payback Method ignores the time value of money, requires and arbitrary cutoff point, ignores cash flows beyond the cutoff date, and is biased against long-term projects, such as research and development and new projects. When comparing the Average Accounting Return Method to the Net Present Value method we found that the Average Accounting Return Method is a worse option than using the Payback Method. The Average Accounting Return Method is not a true rate of return and the time value of money is ignored, it uses an arbitrary benchmark cutoff rate, and is based on accounting net income and book values, not cash flows and market values. Plain and simply put, the Net Present Value method is the best criterion to use when ranking these eight

There are several traditional methods that can be used in appraising investment decisions. For instance, the net present value method (NPV) which entails estimating the costs and revenues of a project and discounting these figures to get their present values. Projects with the biggest positive net present value are the ones chosen as they represent the best stream of benefits of investing in the project over and above recovering the cost of initiating the projects. The discount rate is another method which is similar to the net present value method but reflects more on the time preference. This approach may focus on the opportunity cost of

For this project, the best method to use is the net present value. There are inherently flaws in both IRR and payback period that invalidate them as serious choices for determining a project's value. Payback period ignores all cash flows beyond the payback period, so does not effectively measure the contribution that the project makes to the value of the firm. IRR is better, but does not distinguish between the size of the projects. This weakness is most evident when comparing two mutually exclusive projects of different sizes. The IRR does not distinguish which project adds the most value to the company, only the one with the better return. The NPV distinguishes which option adds the most value to the company. Remember that management's role is to maximize shareholder wealth, and NPV is the measure that tells you which project does that. For this project, IRR is fine because there are no other options, but it is best to be in the habit of using NPV.

As cited by Petrochilos G 2004, the Net Present Value principle advises us to invest

Project appraisal techniques are used to evaluate possible investment opportunities and to determine which of these opportunities will generate the best return to the firm’s shareholders. Therefore, it is vital for the firm if they wish to continue receiving funds from shareholders to employ the best techniques available when analysing which investment opportunities will give the best return. There are two types of project appraisal techniques: non-discounted cash flows and discounted cash flows. The Net Present Value and internal rate of return, examples of discounted cash flows, are in use in many large corporations and regarded as more effective than the traditional techniques of payback and accounting rate of return. In this paper, I