TO: CEO
FROM: BUSINESS CONSULTANT
RE: FORMS OF BUSINESS
DATE: 25 TH MAY, 2019
Introduction
It is critical that the assessment of individual projects be carried out before the projects are initiated. The best way is to analyze the highest Internal Rate of Return (Ross, Westerfield, Jaffe, & Jordan, 2016). By such assessments, managers can avoid projects that could incur losses and adopt profitable projects.
Internal Rate of Return
The metric is a rate of deduction that causes the net present value of entire project cash flows to be the same as zero.
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Advantages
Gives the precise return rate for an individual project in relation to the investment cost.
Disadvantages
The metric does not take into consideration aspects such as duration of the project, project size, or future costs.
Net Present Value
The NPV is a metric that is used to measure the profitability of a project in investment planning and capital budgeting.
Advantages
Shareholders can with clarity, see the amount a project will contribute to their value.
Disadvantages
Most of the future cash projections are assumptions and not real.
Payback Method
This is a metric that measures the time duration before an investment recuperates its capital. The metric can be computed by deducting each cash projection from the initial cash outflow until the attainment of the payback period.
Advantages
Does not involve complex calculations.
Disadvantages
Does not take into deliberation the time worth of cash.
Conclusion
The NPV can be used separately from the payback period, but many investments use both methods. First, the payback period is applied to confine the preferences. Then the NPV is utilized to decide the best project for investment (Ross et al., 2016). Alternatively, the NPV could be utilized first to differentiate the best from the worst projects, and then the payback used to determine which projects have a high internal rate of return.
Reference
Ross, S., Westerfield, R., Jaffe, J. & Jordan, B. (2016). Corporate finance (11th edition). New York, N.Y. McGraw-Hill Education.
