Payback Period

a. Payback Period: Advantages of the method include (1) It is simple to compute and easy to understand and (2) it handles investment risk effectively. Disadvantages of the method include (1) it does not recognize the Time Value of Money and (2) it ignores profitability of an investment. b. Profitability Index: Advantage: It uses time value of money. It is similar to the NPV, and, is easy to interpret. Disadvantage: Similar to the IRR, it may give the wrong decision when choosing between mutually exclusive projects. c. Internal Rate of Return Advantage of IRR: It takes into account the time value of money. Disadvantage of IRR: (1) It can generate two answers for the same input. (if there are more than one negative cashflow years). (2) IRR can pick the wrong project when choosing between two mutually exclusive projects. d. Net Present Value Advantage: NPV is the most widely accepted tool for analyzing projects. It takes into account the time value of money. Disadvantage: It does not take into account the risk of the project. Sometimes companies compensate for risk by raising the expected return on a risky project. 6. Project A

Project B

Initial Outlay 4000 Year Net Cash Flow Each Period

4000 14% discount rate

1

2,003

.877

1756.631

2

2,003

.769

1540.307

3

2,003

.675

1352.025

4

2,003

.592

1185.776

14% discount rate

10,736

6,355.712