Question

What are the pros and cons of the various capital budgeting decision methods (NPV, IRR, MIRR, PB, DPB)? If you had to pick one method to use for all project valuation situations, which one would you pick, and why?

Please explain your answer! I am trying to understand the concept.

Answer 1

PARTICULARS	PROS	CONS
NET PRESENT VALUES	IT CONSIDERS THE TOTAL CASH INFLOWS GENERATED BY A PROJECT OVER ITS LIFE TIME PRESENCE OF TIME VALUE OF MONEY FACTOR IN EVALUATING THE MUTUALLY EXCLUSIVE PROJECT THIS TECHNIQUE IS BEST SUITABLE	NOT SUITABLE FOR PROJECTS HAVING UNEQUAL LIVES AND WITH LIMITED FUNDS INVOLVES CALCULATIONS WITH BIT OF COMPLICATIONS NOT RECOMMENDED FOR PROJECTS WITH DIFFERENT SIZE OF INVESTMENTS
IRR	IT CONSIDERS TIME VALUES OF MONEY AND TOTAL CASH FLOWS IT AIMS AT MAXIMIZING THE SHAREHOLDERS WEALTH IT REDUCES THE UNCERTAINITY AND MITIGATES THE RISK FACTOR	NOT A SUITABLE TECHNIQUE TO EVALUATE MUTUALLY EXCLUSIVE PROJECTS COMPLEX CALCULATIONS
MIRR	THERE IS NO MULTIPLE RATE CALCULATIONS AS IN IRR IT ASSUMES RE-INVESTMENT AT FIRM'S COST OF CAPITAL THEN IRR RATE	NO SUCH MAJOR DISADVANTAGE TILL NOW. DOESN'T HAVE THAT MUCH SCOPE
PB	VERY EASY TO CALCULATE AS IT INVOLVES DETERMINATION OF TIME PERIOD FOR INVESTMENTS TO RETURN BETTER TECHNIQUE FOR SHORTER PROJECT	MAIN DRAWBACK IS THAT IT DOES NOT CONSIDER CASH FLOWS OCCURRING AFTER THE PAYBACK PERIOD TIME VALUE FACTOR IS NOT AT ALL CONSIDERED
DPB	SAME AS PAYBACK PERIOD BUT HERE THE TIME VALUE FACTOR IS CONSIDERED	DRAWBACK IS THAT POST PAYBACK PERIOD CASH FLOWS ARE NOT TAKEN INTO CONSIDERATION

SECONDLY, ALL THE TECHNIQUES HAS THEIR OWN IMPORTANCE AT DIFFERENT STAGES OF PROJECT EVALUATION.

MAJORLY USED TECHNIQUES ARE NPV AND IRR.

I PREFER NPV, BECAUSE IT IS THE MOST COMMONLY AND WIDELY PRACTICED PROJECT EVALUATION TECHNIQUE.

REASON:

• CONSIDERS TIME FACTOR
• BETTER OPTION FOR EVALUATING MUTUALLY EXCLUSIVE PROJECT
• BETTER UNDERSTANDABILITY OF A PROJECT
• INDEPENDENT EVALUATION OF THE PROJECT CAN BE DONE.