Question

In: Finance

I. What are the primary flaws associated with the Payback Period? How would you overcome them?...

I. What are the primary flaws associated with the Payback Period? How would you

overcome them? Give examples.  

II. What advantages does the Modified Internal Rate of Return (MIRR) have over the regular

Internal Rate of Return (IRR)? Provide examples.

Solutions

Expert Solution

1.a) primary flaws which is associated with the payback period method as follows-

A. It does not consider the time value of money and hence it does not account for any kind of inflation.

B.it is always neglecting the cash flows which are received after the payback period.

C. It also does not consider the profitability of the firm.

D. It does not consider the projects return on investment.

One can overcome time value problem by associating them with discounted payback period method and to consider other cash flows after the profitability, one needs to opt through net present value or IRR method.

Example of payback period when the initial investment of a project is recovered within a certain point of time by the cash inflows of the companies, so equivalence point at which the initial investment is equal to the cash flow received of the company is the payback period

II. Advantages of modified internal rate of return over internal rate of return are as follows-

A.calculation through modified internal rate of return eliminate the problem of abnormal cash flows through multiple internal rate of return

B.all cash flows are required to be reinvested with the reinvestment rate rather than internal rate of return.

C.modified internal rate of return method have a wider scope because it gives a more realistic view.

it can be exampled that earlier the project were reinvested with internal rate of return, but now the cash flows are are reinvested into the business with reinvestment rate because it will always yield the required rate of return according to the investment rate so modified internal rate of return is better.


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