I will be analysing your three investment choices using three criteria, the net present value and internal rate of return and payback period. In analysing the following investments I have not taken into account the effects of taxation

Ranking of investments

Investment 3 has the best rating using the three analysis tools, the initial investment is paid back after 5.05 years, followed by investment 2

Limitations of analysis using NPV, IRR and PP

The results given from Net present value are affected by the discount rate and we have to assume that the rate will be the same over the life of the investment, however in reality the costs of money and thus discount rate can change monthly and it is unrealistic to assume that the discount rate will remain the same over the investment life

The internal rate of return does not factor in inflation or when applicable the costs of borrowing money in the rate it gives thus it is a higher rate than it should be as it ignores other costs.

Payback period does not put any value on returns after the initial investment is recouped, it also does not consider any additional outgoings.

Which investment should be chosen?
When selecting which investment risk has to be considered as well as what the other options are. Investment 1 and 2 carry virtually the same level of risk so comparing them is relatively simple just look at the numbers, when looking at the rankings investment 2 clearly outperforms investment 1. When comparing investment 3 to the other investments it is not so straightforward as returns cannot be certain and there are a lot of variables that will affect the return. Investment 2 and 3 both give the required rate of return it is up to you the investor to choose from an adequate return with low risk or a higher return with high risk.

Risks involved in each investment

Investment 1, Inflation is the major risk of this...

...Case 17 – The Investment Detective
The case of the Investment Detective laid out the cash flows for us in each of eight different projects. Before doing any calculations we came up with the assumption that we could not rank the projects simply by inspecting the cash flows.
Without the ability to rank the projects based off of cash flows solely, we had to use some analytical criteria as a capital budgeting analyst to provide some thorough support and reasoning for how we ranked the four best projects. In this case we are only using quantitative considerations that we deem to be relevant and no other project characteristics are deciding factors in our selection of the best four projects. When coming up with our calculations to rank the four best projects we have to take into account that each project is going to require an initial investment of two million dollars and in using historical data from other capital budgeting analysts in the firm, we deemed a ten percent discount rate as an appropriate figure for our calculations.
The analytical criteria in which we feel we gives us the best results to help us choose the top four projects are Net Present Value, Internal Rate of Return, and the Payback Period calculation. We are basing our rankings solely on the results we receive from our Net Present Value calculations because we feel this method to be the most consistent and it also takes into account all of the cash flows as...

...simply inspecting the cash flows. However, it is not a good method to rank the projects. In order to ensure that the investment projects selected have the best chance of increasing the value of the firm, we need tools to evaluate the merits of individual projects and to rank competing investments. In this case, our group using some tools which are Payback Period, Net Present Value (NPV) , Profitability Index (PI), and Internal Rate of Return (IRR). We are only using quantitative considerations that we think to be relevant and no other project characteristics are deciding factors in our selection of the best four projects.
Payback Period
NPV
PI
IRR
Sum of Cash Flow Benefits
Excess of cash flow over initial investment
Project 1
6 years 22 days
$ 73.09
104%
10.87%
3310
1310
Project 2
2 years
($ 85.45)
96%
6.31%
2165
165
Project 3
15 years
$ 393.92
120%
400%
10000
8000
Project 4
6 years 18 days
$ 228.82
111%
12.33%
3561
1561
Project 5
7 years 1 month 20 days
$ 129.70
106%
11.12 %
4200
2200
Project 6
1 year
0
100%
10%
2200
200
Project 7
1 year 10 months 20 days
$ 165.04
108%
15.26%
2560
560
Project 8
6 years 14 days
$ 182.98
109%
11.41%
4150
2150
When coming up with our calculations to rank the four best projects we have to take into account that each project is going to require an initial investment of two million dollars and in using historical data...

...Investment Appraisal
Investment: Spending money into something with an expectation of making profit/ increasing wealth in the future
Investment Appraisal: Is a process of evaluating the attractiveness of an investment proposal using various techniques/methods,
Methods
Payback period
Accounting rate of return (ARR – ROCE)
Investment appraisal
Internal rate of return (IRR)
Pay Back Period (PBP)
The Payback Period (PBP) - The time taken by the project to repay the investment or
The time taken where, Cash inflows = Cash Outflows
* Usually expressed in years
It really considers the flow of cash into the business and outside the business
Decision Rule: A project is good if PBP is either equal or lower than the target period
But PBP is not adequate on its own as an investment appraisal technique.
Example
Project P Project Q
$ $
Capital investment 60,000 60,000
Profits before depreciation (a rough approximation of cash flows)
Year 1 20,000 50,000
Year2 30,000 20,000
Year3 40,000 5,000
Year4 50,000 5,000
Year5 60,000 5,000
Here,
PBP for P More than 2 year
PBP for Q Less than 2 year
So, on the basis of PBP project Q is preferred
However, if we look at the total returns...

...The comparison of NPV & Other investment rules
Comparison of NPV & Other Investment Rules
Capital budgeting is important for a company to make decisions on investments and financing issues. However, there are various methods can be used for corporate financing, among which Net Present Value (NPV) is the best rule which can always lead to the correct choices. Except NPV, the company can also use payback period, discounted payback period method, the internal rate of return (IRR) and the profitability index (PI). The following is the analysis and comparison of NPV and these alternatives.
NPV is the profit a company can obtain from its project and the increase in the value of the shareholders. It considers all estimated cash flows in a project’s life and discounts them to the present value by discount rate to make them comparable. After summing all the present value generated in every period, the company can get the NPV which is the value additivity. This important value additivity can only be directly generated and seen thought NPV rule, while other alternatives cannot provide such information. The company should accept the project only if the NPV is larger than zero and reject it when the NPV is below zero. The discount rate used in calculation should be estimated regarding to the risk level or the expected return of the project, however, it need to be adjusted based on the differences from market risk. NPV rule is...

... 10
Introduction
With the development of business, more and more techniques have been widely used into companies to maximize the wealth. Capital investment appraisal is the budgeting of major capital and investment to company expenditure which facilitates the determination of the concerned firm's investments. Doubtlessly, firms will benefit from modern financial technology. The most common ways of investment appraisal are payback, IRR and NPV methods; each of them has its own strengths and weaknesses from a perspective of decision making. In this essay, the background and methods of capital investment appraisal will be discussed, and then will argue the comparison of different methods.
Background
Capital appraisal is significant in capital budgeting process of company. The process involves decision making on the limited sources and selection of superior projects which provide the board of directors and the managers with the probably result on the final decision. (Pike and Neale, 2006)
The backgrounds should be considered by investors and managers before investment are as follows.
Firstly, the size of a project can be measured by the original funds. Many factors should be considered by directors if the proposal is large enough to change corporate strategy. (Lumby and Jones, 2003)
Next, at the end of investment, companies should estimate their cash flows at an...

...Explain the theoretical rationale for the NPV approach to investment appraisal
and compare the strengths and weaknesses of the NPV approach to two other commonly used approaches.
One of the key areas of long-term decision-making that firms must tackle is that of investment - the need to commit funds by purchasing land, buildings, machinery, etc., in anticipation of being able to earn an income greater than the funds committed. In order to handle these decisions, firms have to make an assessment of the size of the outflows and inflows of funds, the lifespan of the investment, the degree of risk attached and the cost of obtaining funds.
The main stages in the capital budgeting cycle can be summarised as follows:
Forecasting investment needs.
Identifying project(s) to meet needs.
Appraising the alternatives.
Selecting the best alternatives.
Making the expenditure.
Monitoring project(s).
One of the most important steps in the capital budgeting cycle is working out if the benefits of investing large capital sums outweigh the costs of these investments. The range of methods that business organisations use can be categorised in one of two ways: traditional methods and discounted cash flow techniques.
The Net Present Value (NPV) is a Discounted Cash Flow (DCF) technique that relies on the concept of opportunity cost to place a value on cash inflows arising from capital...

...Finance for managers
Chapter 7— Net Present Value and Other Investment
Question 1 : List the methods that a firm can use to evaluate a potential investment.
There are discounted and non-discounted cash-flow capital budgeting criteria to evaluate proposed investments. They are
1) Net present value: NPV is a discounted cash flow technique, which is the difference between an investment’s market value and its cost.
NPV = Present value of cash inflow- Present value of cash outflow
The investment should be accepted if the net present value is positive and rejected if it is negative.
2) Profitability index: PI is a discounted cash flow technique in which present value of an investment’s future cash inflows divided by its initial cash outflow. It is also called benefit/cost ratio.
PI = PV of cash inflows / PV of cash outflows
If PI is positive, it will be accepted otherwise reject.
3) Internal rate of return: IRR is the discount rate that equates the present values of cash inflows with the initial investment associated with the project thereby causing NPV = 0
If IRR ≥ required rate of return the project is accepted. If IRR < required rate of return the project is rejected.
4) Payback period: Payback period is the exact amount of time required for a firm to recover its initial investment in a project as calculated from inflows. It is a...

...Prepare a critical evaluation of three basic methods of evaluating an investment (IRR, Payback and NPV).
There are several basic methods of evaluating an investments that are commonly used by decision makers in both private corporations and public agencies. Each of these measures is intended to be an indicator of profit or net benefit for a project under consideration. Some of these measures indicate the size of the profit at a specific point in time; others give the rate of return per period when the capital is in use or when reinvestments of the early profits are also included. If a decision maker understands clearly the meaning of the various profit measures for a given project, there is no reason why one cannot use all of them for the restrictive purposes for which they are appropriate. With the availability of computer based analysis and commercial software, it takes only a few seconds to compute these profit measures. However, it is important to define these measures precisely.
The internal rate of return (IRR)
The internal rate of return (IRR) is the discount rate often used in capital budgeting that makes the net present value of all cash flows from a certain project equal to zero. This in essence means that IRR is the rate of return that makes the sum of present value of future cash flows and the final market value of a project (or investment) equals its current market value. The higher a project’s internal rate of...