Discussion- Cost of Capital In making the accept/reject decision, each of the capital budgeting decision methods provides decision maker with a somewhat different piece of relevant information. Payback and discounted payback provide an indication of both the risk and the liquidity of a project. NPV is important because it gives a direct measure of the dollar benefit (on a present value basis) of the project to shareholders, so it is regarded as the best single measure of profitability IRR also measures profitability, but expressed as a percentage rate of return, which many decision makers prefer. Further, IRR contains information regarding a project's "safety margin. The modified IRR has all the virtues of the IRR, and it avoids the multiple rate of return problem. The PI measures profitability relative to the cost of a project-it shows the "bang per buck. Like the IRR, it gives an indication of the project's risk, for a high PI means that cash flows could fall quite a bit and the project would still be profitable Quantitative methods such as NPV and IRR should be considered as an aid to informed decisions but not as a substitute for sound managerial judgment. In a perfectly competitive economy, there would be no positive NPV projects-all companies would have the same opportunities, and competition would quickly eliminate any positive NPV. Positive NPV projects must be due to some imperfection in the marketplace, and the longer the life of the project, the longer that imperfection must last. Therefore, managers should be able to identify the imperfection and explain why it will persist before accepting that a project will really have a positive NPV. If you can't identify the reason a project has a positive projected NPV, then its actual NPV will probably not be Positive NPV projects don't just happen-they result from hard work to develop some competitive advantage. Some competitive advantages last longer than others, with their durability depending upon competitors' ability to replicate them. MacBook Air 3 4 5 Discussion- Cost of Capital In making the accept/reject decision, each of the capital budgeting decision methods provides decision maker with a somewhat different piece of relevant information. Payback and discounted payback provide an indication of both the risk and the liquidity of a project. NPV is important because it gives a direct measure of the dollar benefit (on a present value basis) of the project to shareholders, so it is regarded as the best single measure of profitability IRR also measures profitability, but expressed as a percentage rate of return, which many decision makers prefer. Further, IRR contains information regarding a project's "safety margin. The modified IRR has all the virtues of the IRR, and it avoids the multiple rate of return problem. The PI measures profitability relative to the cost of a project-it shows the "bang per buck. Like the IRR, it gives an indication of the project's risk, for a high PI means that cash flows could fall quite a bit and the project would still be profitable Quantitative methods such as NPV and IRR should be considered as an aid to informed decisions but not as a substitute for sound managerial judgment. In a perfectly competitive economy, there would be no positive NPV projects-all companies would have the same opportunities, and competition would quickly eliminate any positive NPV. Positive NPV projects must be due to some imperfection in the marketplace, and the longer the life of the project, the longer that imperfection must last. Therefore, managers should be able to identify the imperfection and explain why it will persist before accepting that a project will really have a positive NPV. If you can't identify the reason a project has a positive projected NPV, then its actual NPV will probably not be Positive NPV projects don't just happen-they result from hard work to develop some competitive advantage. Some competitive advantages last longer than others, with their durability depending upon competitors' ability to replicate them. MacBook Air 3 4 5
