29 May The Payback method simply shows the time that would be needed to regain initial expenses or costs of a project, but does not take the current time value of money into consideration
The Payback method simply shows the time that would be needed to regain initial expenses or costs of a project, but does not take the current time value of money into consideration. This method shows a manager or investor how many months or years it would take to break even once a project is started. Some companies can use this figure as potential cut off evaluation. A payback period less than three years would be accepted, and any longer would not be accepted would be a possible utilization of the calculation. This method does not take into account the profitability of a project once initial costs are recouped, and longer project calculations can be inaccurate due to time issues such as inflation. This could cause a project that is of a longer scope and ultimately more profitable may be rejected instead of a project that has a lower pay back period but is over the life of the project less profitable. This tool would be better utilized for smaller decisions or less demanding project considerations
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The internal rate of return is used to help determine the probability of profit or loss in an investment. The discount rate is used and the net percent equals zero. This calculation can indicate that the higher the rate the better opportunity for growth and profitability. IRR may not be completely accurate if the rate shows as being low however the net present value may be high and add more value to the company than shown by the rate. If possible projects are of different time lengths as well the IRR figures may be inaccurate over the course of the project. Net present value takes into account current cash inflows and outflows. The net present value calculation has a high reliance on market estimates and assumes the highest possible levels of returns. Issues such as more resources being expended initially than planned can make the calculation inaccurate. Relying on stated discount rates and calculated cash flows makes it difficult to place the exact earnings compared to the total costs
posted by JASON
Net present value shows the cash outflows and inflows by using present values. The formula takes into account the time period, the discount rate, initial investment costs, and net cash inflows during a particular project. A positive result would indicate that the project would have sufficient earnings to justify the needed expenses. A smaller or negative result would indicate that the projected costs would be higher than the probable earnings. A company would use this to evaluate in real current dollars if a potential project would be profitable.
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Net working capital affects decision making because of the review of cash flows. Net working capital is the current liabilities and current asset differences. According to Ross, Westerfield, Jaffe, and Jordan (2106), “An investment in net working capital arises whenever (1) inventory is purchased, (2) cash is kept in the project as a buffer against unexpected expenditures, and (3) sales are made on credit, generating accounts receivable rather than cash. (The investment in net working capital is reduced by credit purchases, which generate accounts payable” (pg. 180). Projects would need to be reviewed by how much cash would be generated from it as well as how much cash would be tied up as well. Depreciation would be a factor in decision making in an example like machinery. Due to age new equipment will require servicing and may require replacement during the course of a project. A company taking out debt will be concerned with the interest rate charge that would affect their financials as well.
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