Thus, the payback period for Project A is 2.33 years. The Payback Period Method therefore is a technique used in appraising investments by actually trying to find out the Payback Period of a project. In this way, expected time required to recover the original investment can be calculated.
1.a.ii. Net Present Value Method. With the emergence of discounted cash flow techniques, it has become easy nowadays to implement the net present value method in investment appraisal. The net present value method is a method of ranking investment proposals using the net present value, which is equal to the present value of future net cash flows, discounted at the marginal cost of capital (Brigham, 1992).
1.a.iii. Internal Rate of Return Method. This is a method of ranking investment proposals using the rate of return on an asset investment, calculated by finding the discount rate that equates the present value of future cash inflows to the investment’s cost (Brigham, 1992). The internal rate of return is the discount rate which forces the present value of a project’s inflows to equal the present value of its costs.
In conclusion, it is good to look clearly which among of these three mentioned methods are good. Payback period method is very simple among the three methods. However, with its simplicity come two major weaknesses. It definitely does not take into account the benefits that occur after the payback period. In short, it does not measure the total income. With this, it does not take into consideration the time value of money. It uses cash flows in the calculation but not net income so it has nothing to say much about a project’s total profitability.
The net present value unlike payback period is computed in terms of currency. The net present value accounts for the time value of money, inflation, risk, financing and other considerations which make it a good measure of profitability.
The internal rate of return on the other hand is good when it