The pay back period for project 1 is 2 years and 2 months while the payback period for project 2 is 3 years and 8 months. Judging from the payback period, project 1 is more favorable as there is less risk involved when compared with the risks of project 2. The initial outlay is recovered earlier by project 1. Moreover, the ARR also favors Project 1, therefore the expected profitability of the project is higher than the profitability of project 2.
TASK 2: UNDISCOUNTED CASH FLOW - PAY BACK PERIOD
CASH INFLOW/ OUTFLOW
CASH INFLOW/ OUTFLOW
The payback period for Project 1 is 1 year and 11 months. [Working: 70000 80000 12 months].
The payback period for Project 2 is 2 years.
If the time value of money is ignored, Project 1 is again more profitable as it involves less risk as compared to the undertaken of Project 2 which has a higher payback period.
TASK 3: ADVANTAGES AND DISADVANTAGES:
DISCOUNTED CASH FLOW:
The method takes into the account the time value of money.
It produces more meaningful results than the payback period.
It is more complicated than ARR and Payback and requires a number of calculations if solved manually.
It is simple to calculate.
Calculation of net cash flows is more objective than calculation of profitability.
It indicates the project with the least risk.
It ignores the life expectancy of a project.
Two projects may have a similar payback period even though the pattern of cash inflows may be different.
It ignores the time value of money.
ACCOUNTING RATE OF RETURN
It is easy to calculate.
It can be used to compare the expected profitability of a project with the present profitability of the business.
It is based on average annual profit which may not be similar for each year.
The timing of cash flows is ignored.
It also ignores the time value of money.
There is no commonly accepted method of calculating capital employed.
It takes no account of the duration of the project.
Discounted cash flow. (2007). Retrieved August 17, 2007, from Investopedia Web site: http://www.investopedia.com/terms/d/dcf.asp
Payback Period. (2007). Retrieved August 17, 2007, from 12 manage: http://www.12manage.com/methods_payback_period.html
Randall, H. (1996). Capital Expenditure Appraisal.