The document compares and contrasts three investment evaluation methods: accounting rate of return (ARR), payback period, and net present value (NPV). ARR clearly shows project profitability and allows comparison of multiple projects, but does not consider the time value of money. Payback period is simple to calculate and understand, and identifies quickly recovering projects, but can favor short-term projects. NPV uses all cash flows and properly accounts for the time value of money, though it is more complex. The document also lists four common investment acceptance criteria: projects are accepted if they have positive NPV, payback period less than expected recovery, ARR higher than cost of capital, or profitability index above 1.

1. ADDITIONAL NOTES BM014-3-3-DMKG
INVESTMENT ANALYSIS
Advantages and disadvantages of ARR, Payback method NPV
ARR Payback method NPV
Advantages 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 decision
Investment acceptance criterion:
1-Accept a project if the NPV for the particular project is positive
2- Accept a project if the payback period is less than the expected cost recovery duration.

2. ADDITIONAL NOTES BM014-3-3-DMKG
3- 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.