8. You have just graduated from the Royal Business Collage with knowledge in fin

Question

8. You have just graduated from the Royal Business Collage 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 FIN 8091 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

Advantages of payback period -

1. Easier to use

2. Gives a rough approxmiation of the project viability

Disadvantages of payback method -

1. It does not take into account the cost of captial or the inflation (purchasing power declines with time).

2. It ignores all the cash flows beyond the time horizon which could be substantial.

Advantages of NPV -

1. It is more accurate than Payback period.

Disadvantages of NPV -

1. The discount rate used should be carefully estimated otherwise the calculations will be way off.

Related Questions

Navigate

• Browse (All)
• Browse 8
• Subjects

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