Week 2: Capital Investment Decisions

After accounting for the initial investment, a method known as net present value (NPV)

estimates the present worth of anticipated future cash flows. The main benefit of NPV is that it

takes time value of money into account. Another benefit is that it offers a crystal-clear picture of

an investment's profitability. The requirement for an estimation of future cash flows, which can

be challenging to anticipate, is a drawback of NPV. The fact that it disregards the amount of

investment is another drawback. The internal rate of return (IRR), which is determined by an

investment's anticipated future cash flows, calculates the rate of return on an investment. IRR's

main benefit is that it gives a precise indicator of the possible return (Jiambalvo, 2019). Its ease

of comprehension and application is another benefit. When there are unequal or irregular cash

flows, it can be challenging to calculate IRR, which is a drawback. It also makes the assumption

that capital flows can always be reinvested at the same pace, which is a drawback. The payback

method calculates the amount of time needed for an investment to recover its initial cost.

Payback’s method’s main selling point is how simple it is to comprehend and use. Another

benefit is that it emphasizes the return on the initial investment. Payback method has the

drawback of ignoring the time worth of money, which can be significant. One more drawback is

that it does consider the expected cashflows beyond the payback duration causing suboptimal

investment descisions.
 Reference

Jiambalvo, J. (2019). Managerial accounting. John Wiley & Sons.

https://books.google.co.ke/books?hl=en&lr=&id=QB7HDwAAQBA