Question

What are the advantages of each of below methods? Which method are you likely to accept?

- payback period

- average rate of return on initial investment

- net present value (NPV)

Answer 1

Advantages of payback period are as follows-

A. It will be helpful in selection of projects which are repaying their initial investment within the payback period acceptable to the company.

B. Determination of payback period is easy and it is not a complex process.

C. It will be helpful in reducing the risk of losses.

Advantages of average rate of return on initial investment-

A. it will be primary focusing upon the rate of return and which is most desired by the investor

B.it has the flexibility of being adopted within any time frame and it can be extended to a longer time period also.

C. Calculation of average rate of return on initial investment is most easy and straight forward.

Advantages of net present value method are as follows-

A. Net present value method will be providing for time value of money and it will be properly discounting the risk associated with investment

B. it also incorporates the reinvestment options within calculation of Net present value

C. It is highly compatible and comprehensive method.

D. It can be customised and it is simple to use and it will be helpful in selecting of the best project

if I will have to adopt one method out of all three methods, then I will be selecting the net present value method because it will be incorporated for the time value of money and it can be applied under various circumstances when there will be a nonuniform cash flows and there will also be reinvestment assumptions associated with it so it will be helpful in selection of the best project out there when there will be a different risk associated with external environment.