Bf T3 Prons and Cons Arr (1)
Tutorial 2:
Topic 2:
Discuss the Pros and Cons of the Payback and Accounting rate (ARR) of return. | Advantages | Disadvantage | Payback | * It is using as a supplementary methods of investment technique.Then it is more easily to understand and calculate rather than the other sophisticated methods. * Increasing the efficiency of appraisals process. It is useful in using at early stage to filter the project to avoid premature rejection. * Simple and easy to apply It is a simple and easily to use to communicate an idea of project profitability as the concept is straightforward. * Quick return in minimizing risk.It is able to provide a useful guideline to the exposure of the firm risk. Then, likely that earlier cash flows can be estimated. * It maximizes liquidity when there is a capital shortage.This allowed investing the other profitable projects rather than later funds are limited, through cash forecasting. | * Project return may be ignored. It ignores the cash flows arising after the payback period. Discounted payback tends to lead firms to underinvest in projects that are profitable with long term pay-offs. * Timing ignored. It makes no allowance for the time value of the money. No more accurate measure is made based on the initial investment with the future cash flows. * Lack of objectivity in the selection of the cut-off point. There is no objective to measure to the appropriate time period should be set as the basis. | ARR | * Easily understood and simple. Managers are familiar this measurement because often judged on a profit to assets employed ratio. * Links with other accounting measures. It is a widely reported measure calculated to assess a sector of business. * The ARR can be directly calculated from the accounting data, and information will usually available. * The profitability of the investments can be assessed with ease, using this tool. This tool is extensively used by many accountants today as a performance
Topic 2:
Discuss the Pros and Cons of the Payback and Accounting rate (ARR) of return. | Advantages | Disadvantage | Payback | * It is using as a supplementary methods of investment technique.Then it is more easily to understand and calculate rather than the other sophisticated methods. * Increasing the efficiency of appraisals process. It is useful in using at early stage to filter the project to avoid premature rejection. * Simple and easy to apply It is a simple and easily to use to communicate an idea of project profitability as the concept is straightforward. * Quick return in minimizing risk.It is able to provide a useful guideline to the exposure of the firm risk. Then, likely that earlier cash flows can be estimated. * It maximizes liquidity when there is a capital shortage.This allowed investing the other profitable projects rather than later funds are limited, through cash forecasting. | * Project return may be ignored. It ignores the cash flows arising after the payback period. Discounted payback tends to lead firms to underinvest in projects that are profitable with long term pay-offs. * Timing ignored. It makes no allowance for the time value of the money. No more accurate measure is made based on the initial investment with the future cash flows. * Lack of objectivity in the selection of the cut-off point. There is no objective to measure to the appropriate time period should be set as the basis. | ARR | * Easily understood and simple. Managers are familiar this measurement because often judged on a profit to assets employed ratio. * Links with other accounting measures. It is a widely reported measure calculated to assess a sector of business. * The ARR can be directly calculated from the accounting data, and information will usually available. * The profitability of the investments can be assessed with ease, using this tool. This tool is extensively used by many accountants today as a performance
References: 1. Arnold. G. (2013) Corporate Financial Management, 5th edition. Pearson: United Kingdom. 2. Watson. D. (2007) Corporate Finance:Principles and Pratice ,4th edition.Prentice Hall: United Kingdom. 3. Megginson, W.L., Smart, S.B., & Lucey, B.M. 2008. Introduction to Corporate Finance, China: Cengage Learning: Page 260. 4. Graham, J.R. & Smart, S.B. 2012. Introduction to Corporate Finance, United States of America: Cengage Learning, Third Edition: Page 247.