Question

Identify four capital investment evaluation methods and discuss the strengths and weaknesses of each method.

Answer 1

our capital investment evaluation methods and strengths and weaknesses of each method is shown below:

1. Net present value method

Pros

Provide present value of futures cash flows which helps in taking capital budgeting Decision. NPV method provide more accurate information about the project so is widely accepted method.

Cons

Future cash flow and discount rate is an assumption value which might be differ from actual value.

2. Internal rate of return method

Pros

Provide information about annualize return from project based on cash flows. IRR method is also widely used capital budgeting method.

Cons

1. IRR method it is assume that all cash flow is reinvested at IRR which is not always true.

2. For non-Conventional cash flow, there are multiple IRRs. So, during analysis, it create confusion.

3. Modified internal rate of return method

Pros

It considers reinvestment rate and cost of capital to evaluate the project so provide better result than IRR method.

Cons

To calculated MIRR, it requires two additional information about reinvestment arte and cost of capital which is an assumed value.

4. Payback period method

Pros

Payback period is easy to calculate method for capital budgeting.

Cons

1. It does not consider discounting factor and

2. It does not consider cash flow flows after payback period.

5. Discounted payback method

Pros

Discounted Payback period is easy to calculate method and it consider discounting factor also for capital budgeting.

Cons

It does not consider cash flows after payback period.

6. Profitability index method.

Pros

Provide information about present value of future cash flow is either more than or less than initial investment.

Cons

If there are mutually exclusive project and If initial investment value of one project is high and other have low then it does not provide actual result.