You have just graduated from College with knowledge in finance. Your family has

Question

You have just graduated from College with knowledge in finance. Your family has hired you as the new financial manager. Your grandfather is the current president of the firm. One of the first things you notice is that your family’s firm uses payback to make its capital investment decisions. You remember your training in Finance and know this isn’t correct. Tell your grandfather (very diplomatically as he could fire you!) why he should use net present value as the method of analysis. In doing so, give any advantages and disadvantages for both NPV and Payback.

Explanation / Answer

When compared with payback method NPV is more accurate and useful method to evaluate a project. NPV is called net present value where all the net cash flow of the project during the project timeline will be discounted to present using the cost of capital. If NPV is positive we will accept and it is negative we will reject.

Disadvantages of payback:

1)Will not discount the cash flow using the cost of capital means time value of money is neglected

2)It ignores the cash flow occured after the time horizon. Meaninfg if cash flow occured after the payback is positive then it is ignored

Advantages: of payback:

1)It is easy to calculate and understand

Related Questions

Navigate

• Browse (All)
• Browse Y
• Subjects

Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.