The payback period is the time it takes for a project or investments cash outflows to be recovered by cash inflows generated from the same project or investment. It is a very simple and commonly used capital budgeting technique. The formula used to compute the payback period is initial investment divided by cash inflow per period.
You generally want to choose the investment that provides the shortest payback period, because you will get you cash back and it can be put toward other investments or projects. The longer the payback period the riskier it is.
Top management will normally have a target payback period. They should select the project that offers a payback period less than the target. There are a few advantages of using the payback period calculation. It is very simple to calculate, and it is a good measure of risk in a project. As stated before, the longer it will take to return the money on the project the riskier it is.
Also, for companies that have liquidity problems, it provides a good resource on what investments will return money the quickest. A big disadvantage of the payback period is that it does not take into account the time value of money which can lead to wrong decisions. It also ignores any benefits that occur after the payback period, so it does not accurately measure profitability.
The discounted payback period is also used to compute the time it takes to recover the cost of an investment, but it works to correct the disadvantage of the payback period by accounting for the time value of money. To calculate the discounted payback period, a discounted cash flow is used in the calculation.
Evaluation Essays Ruff Ryders And Cash Money Millionaire Concert
Grade B+Evaluation Essay Ruff Ryders and Cash Money Millionaires This concert was held on Thursday March 2, 2000. Some of the hottest rap and r&b artists included in this mix were DMX, Juvenile, Ruff Ryders, Drag On, Hot Boyz, Eve, The Lox, Lil Wayne, Big Tymers, and B. G. It was hosted at the Marine Midland Arena in Downtown Buffalo. Tickets ran anywhere from$40. 00 to $55. 00 for the five ...
The discounted cash inflow is calculated by dividing actual cash inflow by the present value of each cash inflow. To do this management has to establish an appropriate discount rate. The advantages of using the discounted payback period is that it accounts for the time value of money, and it provides management with a more accurate estimate of when an initial investment will be recovered.
A disadvantage of the discounted payback is that no matter when a cash flow is received, it will always be given the same weight as the first year. This could cause management to overstate the payback period. The discounted payback period still does not consider the cash flows beyond the payback period.
If a project runs longer than the calculated payback period, cash flows generated afterward are not going to be used in the payback period calculation. Another disadvantage is that it does not give management a solid base to make an investment decision.
This is because the company is guessing the interest rate used in calculating the discounted cash inflow, so the calculations may not be completely reliable. Even though it has its flaws, the discounted payback period is better than the regular payback period since it does discount the cash flows.
Net present value determines whether a project’s rate of return is equal to, higher, or lower, than the desired rate of return. It represents the net cash benefit or cost of acquiring the proposed project or asset. The net present value is also calculated using discounted cash inflows and a target rate of return determined by management. A project should be accepted if the net present value is positive or zero.
A net present value of zero means the projects actual rate of return is equal to the required rate of return. A company will want to select a project with the highest net present value. A major advantage of the net present value method is that it accounts for the time value of money making it more reliable than the payback period.
The Term Paper on The internal rate of return (IRR) and the net present value (NPV)
... capital projects by using cash flows as well as the time value of money. The Internal Rate of Return is the discount rate where the Net Present ... net present value, which equals $8,881. Since the NPV is greater than zero, the corporation should invest in the project. The Internal Rate of Return ...
A disadvantage is that it is based on estimated values of cash flows for the project or asset and estimates may be far different from the actual results.
The internal rate of return is the discount rate that causes the present value of the net cash inflows to equal the present value of the net cash outflows. Therefore, it is the discount rate at which the net present value of an investment equals zero.
A project should be accepted only if the internal rate of return is more than the target internal rate of return. The project with the highest value should be accepted. Although, the internal rate of return method is quite accurate, it does have some disadvantages.
When uneven cash flows are involved, the interactive process is inconvenient and time consuming. Also, if there are fractional interest rates and a present value table doesn’t account for this then the internal rate of return will be difficult to determine. In some instances, certain projects may have several rates of return that will make the net present value of cash flows to equal zero.
The modified internal rate of return is also the discount rate at which the net present value of an investment equal zero, but it is an improved version of the internal rate of return as it does not require the assumption that project cash flows are reinvested as the internal rate of return but it determines a reinvestment rate.
If the modified internal rate of return is greater than the project’s hurdle rate, which is the rate of return specified as the lowest acceptable return on investment, then the project should be accepted. If choosing between several projects, the one with the highest rate would be the best option. The advantage of the modified internal rate of return is that it solves some of the problems associated with the regular internal rate of return.
The Term Paper on Behavioral Aspects of Project Management
Organizational culture can influence the overall success of a project. Unfortunately, in the given scenario the project is both behind schedule and over budget. Several key team members left in disgust and the morale of the remaining team is low and they fear they will be doing extra work without compensation. In this scenario project leadership is essential to the projects success. This project ...
The modified rate of return considers that funds reinvested are going to be at a rate closer to a firm’s cost of capital instead of the same rate of return as the project that generated them. This will provide a more accurate picture for management.
Also, the modified internal rate of return only has one value, so a company doesn’t have to worry about the internal rate of return providing more than one value with a net present value equal to zero. This eliminates confusion.
The two methods I would choose when evaluating a capital expenditure are the net present value method and the modified internal rate of return. These methods provide a more accurate and advantageous result than some of the other options, like payback period and internal rate of return.
They both make up for some of the disadvantages the payback period and internal rate of return have by accounting for the time value of money and considering different rates of reinvestment. The net present value method and modified internal rate of return will provide management with more accurate values for them to base their decisions off of.
