Question

1. List and describe, then compare and contrast the four methods used in capital investment analysis. 2. What is the implication regarding a project's return if the project has an investment cost of $400,000, a minimum rate of return of 12% and a positive NPV of $47,000? Answer the above questions. Answers must be at least 300 – 500 words in length

Answer 1

SOLUTION

There are different methods adopted for capital Investment.

1) Payback period

2) Accounting rate of return method.

3) Discounted cash flow method includes the NPV method,

4) Profitability index method.

- Payback period Method

As the name suggests, this method refers to the period in which the proposal will generate cash to recover the initial investment made. It purely emphasizes on the cash inflows, economic life of the project and the investment made in the project, with no consideration to time value of money. Through this method selection of a proposal is based on the earning capacity of the project. With simple calculations, selection or rejection of the project can be done, with results that will help gauge the risks involved. However, as the method is based on thumb rule, it does not consider the importance of time value of money and so the relevant dimensions of profitability.