Capital budgeting analysis

Advantages of the Discounted Payback Method

1. 
   Includes time value of money.
   
2. 
   Easy to understand.
   
3. 
   Does not accept negative estimated NPV investments.
   
4. 
   Biased toward liquidity.
   

Disadvantages of the Discounted Payback Method

1. 
   May reject positive NPV investments.
   
2. 
   Requires an arbitrary cutoff point.
   
3. 
   Ignores cash flows beyond the cutoff date.
   
4. 
   Biased against long-term projects, such as research and development, and new projects
   

3. 
   Average Accounting Return [AAR]
   

Average accounting return is the investment’s average net income divided by its average book value

A project will be accepted if its average accounting return exceeds a target average accounting return.

Advantages

It is easy to calculate.

The needed information will usually be available.

Disadvantages

It is not a true rate of return because the time value of money is ignored.

Its uses an arbitrary benchmark as a cutoff rate

It is based on the accounting (book) values, not cash flows and market values.

4.