ACCT 102 Chapter Notes - Chapter 9: Payback Period, Capital Budgeting, Net Present Value
Document Summary
Capital budgeting the process of making long-term planning decisions for investments. Accounting rate of return (arr), aka simple rate of return. Net present value (npv), aka dcf (recognize time value of money) Internal rate of return (irr), aka time-adjusted rate of return, aka dcf (recognize time value of money)- Payback period the length of time required to recover the amount of initial investment. Payback period (yrs) = amount of initial investment/cash inflow through increased revenues or cost savings. When cash inflows are uneven, the payback period is determined by trial and error. Decision rule: choose the project with the shorter payback period (less risk and more liquidity) Advantages: simple to use and easy to understand, handles investment risk effectively. Disadvantages: does not recognize time value of money, ignores the impact of cash inflows after the payback period; it is cash flows after the payback period, which determine profitability of an investment.
