587 words - 2 pages

AdvDistable

Advantage and disadvantages of the different capital budgeting techniques Prepared by Pamela Peterson-Drake, Florida Atlantic University

Payback Period

Advantages Disadvantages 1. Simple to compute 2. Provides some information on the risk

of the investment 3. Provides a crude measure of liquidity

1. No concrete decision criteria to indicate whether an investment increases the firm's value

2. Ignores cash flows beyond the payback period

3. Ignores the time value of money 4. Ignores the risk of future cash flows

Discounted Payback Period

Advantages Disadvantages

1. Considers the time value of money 2. Considers the riskiness of the project's

cash flows (through the cost of capital)

1. No concrete decision criteria that indicate whether the investment increases the firm's value

2. Requires an estimate of the cost of capital in order to calculate the payback

3. Ignores cash flows beyond the discounted payback period

Net Present Value

Advantages Disadvantages 1. Tells whether the investment will

increase he firm's value 2. Considers all the cash flows 3. Considers the time value of money 4. Considers the risk of future cash flows

(through the cost of capital)

1. Requires an estimate of the cost of capital in order to calculate the net present value.

2. Expressed in terms of dollars, not as a percentage.

Profitability Index

Advantages Disadvantages 1. Tells whether an investment increases

the firm's value 2. Considers all cash flows of the project 3. Considers the time value of money 4. Considers the risk of future cash flows

(through the cost...

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