Please compare the advantages and disadvantages of the...

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†¦show more content†¦The unmodified IRR method, as compared with the NPV method, will not show the superiority of any two mutually exclusive investments with two different initial outlays. In such a case, an investment with lower IRR c ould have a higher NPV and therefore should be chosen by an investor. In some cases where there are streams of positive and negative cash flows in an investment, the IRR method may yield more than one IRR. This is not a disadvantage if the calculations are performed correctly. Profitability index identifies the relationship of investment to payoff of a proposed project. The ratio is calculated by present value of future cash flows over present value of initial investment. Profitability Index is also known as Profit Investment Ratio. The Profitability index tells whether an investment increases the firm’s value. It considers all cash flows of the project , time value of money and the risk of future cash flows through the cost of capital. It is useful in ranking and selecting projects when capital is rationed. But it need require an estimate of the cost of capital in order to calculate the profitability index. It may not give the correct decision when used to compare mutually exclusive projects. Moreover, it only used for divisible projects. The strategic values of projects are not considered, only figures are dealt with not long term not short term. It limited use when protect have differing cash flow pattern and only limitedShow MoreRelatedBusiness Finance Written Assignment1238 Words   |  5 Pagesneeded for you to obtain arbitrage in each of the forms of market efficiency. (5 points) Q2. Please compare the advantages and disadvantages of the following investment rules: Net Present Value (NPV), Payback Period, Discounted Payback Period, Average Accounting Return, Internal Rate of Return (IRR) and Profitability Index (PI). (You can start by considering the following questions for each investment rule: Does it use cash flows or accounting earnings? Does it consider all cash flows or not? 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