Please compare the advantages and disadvantages of the following investment rules: Net Present Value (NPV), Payback Period and Discounted Payback Period
Net present value is defined as the total present value (PV) of a time series of cash flows. It is a standard method for using the time value of moneyto appraise long-term projects. Used for capital budgeting, and widely throughout economics, it measures the excess or shortfall of cash flows, in present value terms, once financing charges are met. The advantages of the NPV are following; first, it tells whether the investment will increase the firm’s value. Also, it considers all the cash flows, time value of money and the risk of future cash flows through the cost of capital. Moreover, It will give the correct decision advice assuming a perfect capital market. It will also give correct ranking for mutually exclusive projects. NPV gives an absolute value. However, it requires an estimate of the cost of capital in order to calculate the net present value. Also, it expressed in terms of dollars, not as a percentage. It is very difficult to identify the correct discount rate. NPV as method of investment appraisal requires the decision criteria to be specified before the appraisal can be undertaken.
Payback period in business and economics refers to the period of time required for the return on an investment to "repay" the sum of the original investment. The payback Period have different kind of advantages, it is simple to compute, For example, a $1000 investment which returned $500 per year would have a two year payback period. Also, it provides some information on the risk of the investment and provides a crude measure of liquidity. However, it has no concrete decision criteria to indicate whether an investment increases the firm 's value. Also, it ignores the cash flows beyond the payback period, time value of money and the risk of future cash flows.
Discounted Payback Period means the length of time required to recover the initial cash outflow from the discounted future cash inflows. This is the approach where the present values of cash inflows are cumulated
Payback period in business and economics refers to the period of time required for the return on an investment to "repay" the sum of the original investment. The payback Period have different kind of advantages, it is simple to compute, For example, a $1000 investment which returned $500 per year would have a two year payback period. Also, it provides some information on the risk of the investment and provides a crude measure of liquidity. However, it has no concrete decision criteria to indicate whether an investment increases the firm 's value. Also, it ignores the cash flows beyond the payback period, time value of money and the risk of future cash flows.
Discounted Payback Period means the length of time required to recover the initial cash outflow from the discounted future cash inflows. This is the approach where the present values of cash inflows are cumulated