Investment analysis

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Investment analysis

  1. 1. ADDITIONAL NOTES BM014-3-3-DMKGINVESTMENT ANALYSISAdvantages and disadvantages of ARR, Payback method NPV ARR Payback method NPVAdvantages It clearly shows the It is simple to calculate It uses all the cash profitability of an and understand, this may flows of the projects. investment project. be important when Other approaches It allows for a range of management resources ignore cash flows projects to be compared are limited. beyond a particular It is easier to identify the date. opportunity cost of It is simply helpful in investment communicating NPV discounts the information about cash flow properly. minimum requirements to Other approaches may managers responsible for ignore the time value submitting projects. of money when handling cash flow. It uses cash flows rather than accounting profit It can be used as a screening device as a first stage in eliminating obviously inappropriate projects prior to more details evaluation. It can be used when there is a capital rationing situation to identify those projects which generate additional cash for investment quickly.Disadvantages It does not take into It tends to bias in favor of account the effects of short-term projects means time on the value of that it tends to minimize money, nor the level of both financial and risk involved in an business risk. investment decisionInvestment acceptance criterion:1-Accept a project if the NPV for the particular project is positive2- Accept a project if the payback period is less than the expected cost recovery duration.
  2. 2. ADDITIONAL NOTES BM014-3-3-DMKG3- Accept a project if the ARR is higher than the cost of capital incurred by the firm.4- Accept a project if the profitability index is higher than 1.

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