NPV, IRR and Payback Period

Executive summary

The report’s purpose is to provide an analysis of cooperate financial theory, and the constructs relevant and existing in the speculation of issuance and investment management (Baker & Powell, 2005). A variety of issues that are critical are associated with cooperate financial theory. The report defines, analysis and evaluates the issues and their significance to financial theories, marketing and management in relation to design of investment portfolios, and business acquisition process of an investment plan. Once the reference terms are inculcated, the paper provides a conceptual flow. The conceptual flow aims at analyzing how businesses perceive and manage the expectations of their customers and investors (Cam Merritt, 2015). An organization’s ability to incorporate and streamline its policies to meet the expectations of the customers is essential to the success of an investment plan. Furthermore, an evaluation is done on the design of the investment plan and the customer as a function to create a potential investment portfolio to attract investors. Management of customers enhances and stabilizes organizational experience in the market. The stability is essential to the success of the business (Baker & Powell, 2005). On the other hand, management of capital assets in the business increases potential investors in the business. Therefore, it is inherent to balance the two extremes to guarantee the success of the business.

Introduction

The world today is filled with many investment opportunities. These investments promise good returns in the future but the returns only come after a considerable amount of funds is injected in them. For this reason, investors are usually keen to know which investments will give them higher returns and also in what period of time (SIDDAIAH, 2009). Investments that take long to repay the amounts injected to them are usually not favoured because as time passes, inflation may occur reducing the purchasing power of money invested. This would be a loss to the investors. In some instances, a number of investing opportunities may present themselves all at once. For this reason, investors always compare the investments and settle on the one with the highest returns.

To make informed decisions on the best investment opportunities, investors use accounting ratios. These ratios give a clear picture of when an investor is due to receive returns as well a guiding them to the best projects to invest their money into (Baker & Powell, 2005). This paper will focus on three ratios; payback period, net present value and internal rate of return for investment appraisal purposes.

NetPresent Value

Net Present Value or NPV is used to compare the amount of funds invested to the present value of future returns to be received from the investment in question. The amount of funds invested is put side by side to the future returns after discounting by a given rate of return (SIDDAIAH, 2009).  This is a good way of knowing whether a project is worth investing in. A project with a positive net present value is always given a go ahead since it shows that the initial capital will be recovered unlike one with a negative net present value.

The use of net present value to appraise projects has some advantages. One advantage of using NPV is that it puts time value of money in consideration. This method uses the principle that money today is worth more than tomorrow, it therefore changes future cash flows to today’s value (SIDDAIAH, 2009).. This is useful when comparing investments with diverse cash flow patterns.

This method seeks to maximize the worth of a company. It does this by advising company owners which projects to invest in by showing them that a project with a higher NPV is worth investing in. As such, company owners make informed decisions on good projects sine they will maximize profits in them.

Example of NPV

An investor wants to invest in a project that has an initial investment of $240,000 with the following cash flows and a cost of capital of 9%

Order Now

Share this

Share on FacebookPlus on Google+