What is payback period?
This is the time taken for a project to recover its initial investment.
How do you calculate payback period?
Add up annual cash inflows then stop when they equal the initial cost.
What is the best decision for payback period?
Shorter payback is more preferred as this is good for liquidity and risk.
What are the limitations of payback period?
Ignores cash flow after payback
Ignores time value of money
What is net present value?
This measures the present value of future cash flows MINUS the initial investment.
What is the formula for net present value?
Present value of inflows - initial investment
What is the decision rule for net present value?
Accept if the net present value is above 0
Reject if the net present value is below 0.
A positive indicates project added value
What are the limitations of net present value?
Relies on estimates
Sensitive to discount rate
What is the ARR
The formular is average annual profit / initial investment x 100
What is the decision rule with ARR?
The higher the ARR the better
What are the limitations of ARR?
Uses profit not cash
Ignores time value of money
What are some risk uncertainty and qualitative factors?
Market demand uncertainty
Technological changes
Economic conditions (interest rates)
Brand reputation
Ethical/environmental concerns
