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home / study / business / finance / finance questions and answers / Please Give Us One Example From Your Research, Work, Or Personal Life Discussing The Basic ... Question: Please give us one example from your research, work, or personal life discussing The basic types... Please give us one example from your research, work, or personal life discussing Different methods of capital budgeting rationalization such as NPV, IRR, and Payback

Answer 1

There are various methods of capital budgeting which are used by the corporate to analyze the projects. They are:

(1) Pay Back method: The Payback period method is aimed to know what is the repayment time during which the initial capital will be recovered from the project. This is the oldest method and the most simple method. But the main drawback of this method is that it does not take into account the time value of money which is very crucial when it comes to analyzing the cash flows from the project.

(2) Average Rate of Return method: The Average Rate of Return method is also simple as it tell us the average return from the project but this method also fails to take into consideration the time value of money which is the main drawback of this method.

(3) NPV method: The another method which is Net Present Value (NPV) which is the most widely used since in this method, the present value of the cash flows is taken into consideration. The criteria here is that if the NPV of a project is positive then accept the project and if the NPV of project is negative then it is negative. In this method the present value of the future cash flows is calculated taking into account discount rate (hurdle rate).

(4) IRR method: The Internal Rate of Return (IRR) method is one where again the present value of future cash flow is taken but here the trial and error is used to select the discount rate.

(5) Profitability Index method: The last method is the Profitability index where if the Profitability index calculated is more than 1 then it is accepted and vice versa.