Question

the following techniques for analyzing projects:

1. Payback Rule
2. Discounted Payback Period
3. Net Present Value
4. Internal Rate of Return

Why must corporate managers use multiple techniques of project evaluation?

Which technique is most commonly used and why?

Describe several ways the techniques above can be used as one progresses in their professional career. (Identify specific types of projects that can be analyzed and discuss the advantages and disadvantages of using the techniques above)

Answer 1

To achieve goal of cost-effective allocation of capital, investors use different methods to assess the rationality of investment. Although the most comprehensive method is the NPV method, however, based on the information available, corporate managers may use alternative methods with inherent advantages and disadvantages as follows:

1. Payback Period: It is the quickest method and provides quick estimate of the time needed for the company to get back the money invested in the project The length of the project payback period helps in estimating the project risk. However, it ignores the time value of money and may cause company to place importance on projects with short payback period neglecting the need to invest in long-term project.

2. Discounted Payback:Some companies prefer to calculate the payback period as it considers the time value of money.

3. IRR: IRR does not account for changing discount rates without modification , so it is not adequate for longer-term projects with discount rates expected to vary. Further, it doesn't take into account changing factors such as different discount rates and net present value would be more beneficial.

4. NPV Method: The advantage to using the NPV method over IRR using the example above is that NPV can handle multiple discount rates without any issue.

The net present value shows how profitable a project will be versus comparable scenarios and alternatives and is the most effective method.