ARR, PP and DPP - some advantages and disadvantages PDF

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some advantages and disadvantages...

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Average rate of return: accept investment projects with an ARR that is greater than target ARR. If mutually exclusive, accept the project that has the highest ARR. Advantages: 1. Profit based: links to ROCE (return on capital employment) and financial performance. Disadvantages: 1. 2. 3. 4.

Time: takes almost no account of the timing of profit generation Time value of money: does not reflect Accounting: distortion Averages: crude; distortion

Payback period: accept investment projects that are lower than target payback. If mutually exclusive, accept the investment project that has the lowest PP. Advantages: 1. Time: takes account of the timing of cash flows (up to the PP) Disadvantages: 1. Time: fails to reflect all relevant cash flow after PP 2. Time value of money: does not reflect

Discounted payback period: accept investment projects that are lower than target DPP. If mutually exclusive, accept the project that has the lowest DPP. Advantages: 1. Time: takes account of the timing of cash flows (up to the DPP) 2. Time value of money: reflects Disadvantages: 1. Wealth maximisation: fails to priorities. Shorter term projects might promote liquidity but not wealth 2. Time: fails to reflect all relevant cash flows after PP

General advantages of three method above: 1. Calculation: quick and easy to calculate (PP is the quickest and easiest one) 2. Easily understood: clear results 3. Risk: reflects the importance of liquidity (only for PP and DPP) 4. Cash based: not distorted by accounting (only for PP and DPP)

General disadvantages: 1. Wealth maximisation: fails to prioritise 2. Risk: crude approach. Other risk? 3. Acceptability: business will need to determine acceptable ARR/PP/DPP...