Disadvantages Of PBP

To what extent is NPV an effective Investment appraisal tool?

Capital Budgeting:

To understand the value of NPV, the identification of its purpose in capital budgeting should be addressed beforehand, with its alternatives. This process of Capital Budgeting refers to the evaluation of potential in large scale business expenses and investments over long-term ventures. Often this step in the investment appraisal assessment, identifies the cashflows over the projects life-span, determining its generated returns in comparison to the organisations benchmark targets. (Book)

Flowton’s options of replacing its older systems (Project A) or upgrading them to a centrally controlled platform (Project B) are considered such a venture.

Ideally, Flowton would

PBP is calculated, by taking the total cost of the project and dividing it by expected cash inflows received each year; providing the total number of years taken to repay the investment, a shorter PBP equates to a higher return on the capital investment. Usually, this aspect of timing is performed with a maximum payback period, thereby only projects which meet the requirement are considered.

The advantages: The PBP method holds popularity with business analyst for several reasons. First is its simplicity, for its an easily understood concept to teach within an organisation of varying backgrounds. It identifies projects that provide the fastest return on investments, which holds importance for organisations which have limited capital and would need high recovery rate, specifically within SME’s.

Secondly, managers and analyst can utilise this method to make snap evaluations on small project investments which require little to no manpower, or thought into rigorous economic analysis. Specially, this would be used on projects with a lifespan below 3

(Book ref)

Its calculations resemble the NPV formula with few alterations, as its taken with a neutral NPV (zero value) and is to identify the discount rate instead. This outcome is the investment’s IRR, representing the project’s annual rate of growth for that capital investment, granting a comparison for a variety of investment types and lengths to its anticipated profitability.

The Advantages: In its method of calculation alike NPV the IRR is measured using the concept of the “time value of money” and accommodates all future cashflows, generating results that are weighted equally to another.

Another notable strength is IRR methods simplicity which can be adopted against various projects in consideration, providing important presentation values of capital projections. Likewise, these values can be used to bring to light an opportunity or savings of new equipment or