Tuesday 29 March 2011

Advantage and disadvantage of Investment Appraisal Tools

Problems make investment decisions for a business or company need to be evaluated and scrutinized by investors when investors always want to earn profits for themselves, but there are also risks losing. To help investors do this, they need to use the Investment Appraisal Tools as Payback Period, Accounting Rate of Return, Net Present Value (NPV), Internal Rate of Return (IRR) and Discounted Cash Flow (DCF) which build detailed reports on the issues involved and influential in the investment process, predicting that adversely affect the investment process. From there we made the investment options most appropriate.
NPV
NPV normally be considered not only indicators but also are considered the best method to assess the profitability of the project because they show the project's net income after recovery of initial investment capital and cover all costs (including inflation). (Arnold C. Harberger, 1972)
However, the NPV method has disadvantages that require precise calculation of costs, but this is often difficult to implement for long projects. So in reality it is a development cost of capital discount rate (usually due to investor expectations on the basis of calculations to consider the factors that impact on investment projects). (Michael Roemer and Joseph J. Stern,1975
One other disadvantages of the NPV do not show profitability calculated at the percent rate thus affecting the difficult choice of investment opportunities.
IRR
IRR can be calculated by interpolation as the under block and the above block, however, thanks to the application of Excel, the IRR calculation easy. It is important to understand the meaning of IRR. If this value is greater than the value of the discount rate (opportunity cost) when that the project worthwhile. (Donald R. Lessard and Daniel L. Wisecarver)
IRR method has the advantage of easy calculation because regardless of the cost of capital, very convenient to compare investment opportunities because profitability were showed as a percentage. The core meaning of IRR show for investors can know the cost of capital using the highest possible acceptable. If they exceed so capital using is inefficient. (Donald R. Lessard and Daniel L. Wisecarver, 1975)
Disadvantages of the IRR is calculated on the basis of cost of capital will thus could lead to identifying the profitability of the project. Investors will not know how much money they have. (Arnold C. Harberger, 1972)

No comments:

Post a Comment