payback period

average rate of return formula

((total returns-capital cost)/ years of usage)/capital cost x 100

why is net present value useful

- considers the time value of money - how much should I invest today if I want $X in the future - the value of money is affected by interest rates - the NPV is the only one of the three investment appraisal methods which takes the time value of money into account

disadvantages of payback period

- it does not consider the cash earned after the payback period which could influence major investment decisions - it ignores the overall profitability of an investment project by focusing only on how fast it will payback - the annual cash flows could be negatively affected by unexpected external changes in demand which could negatively affect the payback period

disadvantages of net present value

- it is more complicated to calculate than payback period or ARR - it can only be used to compare investment projects with the same initial cost outlay - the discount rate greatly influences the final NPV result obtained, which may be affected by inaccurate interest rate predictions

advantages of average rate of return

- shows the profitability of an investment project over a given period of time - unlike the payback period, it makes use of all the cash flows in a business - it allows for easy comparisons with other competing projects, for better allocation of investment funds - a business can use its own criterion rate and check this with the average rate of return for a business, to assess the viability of the venture

advantages of payback period

- simple to calculate - easy to understand the result - it works best in short-term and so is less inaccurate than other methods - firms with cash flow problems want to pay back loans more quickly, so this figure will be useful to them

advantages of net present value

- the opportunity cost and time value of money is put into consideration in its calculation - all cash flows including their timing are included in its computation - the discount rate can be changed to suit any expected changes in economic variables such as interest rates variations

disadvantages of average rate of return

since it considers a longer time period, there are likely to be forecasting errors. Long-term forecasts decrease the accuracy of results

Net present value

the value of a sum of money, compared with the value of the same sum of money in the future (the measurements of the profitability of a venture by comparing the present value of money with the future value of money)

payback period

this method estimates the length of time required for an investment to recover its initial outlay in terms of profits and savings

average rate of return

this method measures the annual rate of return on an investment as a percentage of its capital cost. it assesses the profitability per annum generated by a project over a period of time

formula of net present value

total present values - original cost