cash flows may be difficult to estimate, particularly in Years beyond the next/total amount of investment is ignored.Thus an investment with an early payback may Be preferred to one which although takes longer to payback, might generate Greater return/the method is absolute;there is no indication of what is an acceptable payback period, except, Intuitively it should be short.Not only Is the yardstick flawed, its length can vary according to economic Circumstances, and the trading position of the firm/cash flows after the payback point are ignored/the time value of money is not considered.
easy to calculate/shows the extent of “exposure” Involved in invested funds/works on cash flow (correct) thus does not need to Consider depreciation, profits and/or losses on sales of fixed assets, etc.SHORT
NET PRESENT VALUE
Advantages:-net Cash flows emphasiseliquidity/the Firm’s accounting policies with regard to profit, asset valuation, depreciation, Etc. Are not relevant/the time value of money, and thus future cash flows is Taken into account/comparison of project through the respective sizes of their NPVs is easy.
Disadvantages:-difficulties In estimating timing of cash flows, also their magnitude/this becomes Especially difficult with time periods well into the future/the choice Of discount rate is subject to debate. It must reflect a realistic assessment Of what the cost of capital is likely to be over the whole life of the Investment, and in times of uncertainty (for evermore?) the temptation is to Overstate the % rate used, to “allow a bit of leeway for the uncertainty of the Future”
INTERNAL RATE OF RETURN
Advantages: using Net cash flows emphasises liquidity/the firm’s accounting policies with regard To profit, asset valuation, depreciation, etc. Are not relevant/the time value Of money, and thus future cash flows is taken into account/the answer, in terms Of a %, appears more “understandable” to management/the IRR can be compared to A “hurdle” rate adopted by the firm;this sets a rate above which all acceptable investments must lie.
Disadvantages:-difficult To choose an appropriate rate if simple interpolation is being used/concept is Difficult to understand/the assumption that all cash inflows are Re-invested at the prevailing IRR rather than some market rate (as in NPV) is Fundamentally flawed/in some cases, particularly those with complex cash flows (inflows and outflows occurring throughout the period rather than one single Outflow followed by a series of inflows) the solution to the IRR expression Will have several “answers”