In view of the relevant strengths and weaknesses of different methods of investment appraisal we would recommend Net Present Value

(NPV) to take into effect on a business project for the right investment decision. The key reasons for why we put preference on NPV rather than other methods i.e. Internal Rate of Return (IRR), Pay Back, Accounting Rate of Return etc would be clarified from the comparison table given below:

Points of Comparison 1. Time Value of Money

NPV It is considered as the basis of calculating NPV.

IRR It is considered in another way while more focuses are on finding an appropriate discounting rate that will make the cash inflows equal the initial outlay. It acts upon only those cash flows which are invested at the IRR.

Pay Back It is not at all considered.

Accounting Rate of Return It fails to consider the Time Value of Money.

2. Cash Flows

3. Variation of Projects

NPV involves all the cash flows occurring during a project life and assumes that these are invested at the cost of capital. It works well with independent as well as mutually exclusive projects

It does not account for the cash flows after the period of recouping the initial outlay.

It does not include all project life cash flows.

It sometimes produces variable results for mutually exclusive projects.

It is inconsistent with the projects that yield negative cash inflows after the payback period.

4. Level of Difficulty of Calculatio

An Easier method with the use of NPV Table.

Comparativel y difficult and time consuming as

It is the easiest method to formulate

It is not always preferred as it ignores the absolute values of cash inflows of a project and just relies on percentage rate. Relatively easier method but not fully

it compares between two different discount rates.

Investment Appraisal.

reflecting on getting a sound investment appraisal.

A Real Life Example of NPV: ZnZ Essentials PLC is planning to purchase machinery for their newly built production unit. They are evaluating the projected cash flow profile of two machines. The discount rate is 7% which is chosen considering the market interest rate. The Company performs the NPV method to prepare the investment appraisal. The NPV of two machines are calculated below using the NPV Table: Machine A Year 0 1 2 3 4 5 Cash Flow (13200 0) 35000 42000 50000 48000 44000 Discount Factor (7%) 1.000 0.935 0.873 0.816 0.763 0.713 Total NPV= NPV() (132000) 32725.0000 36666.0000 40800.0000 36624.0000 31372.0000 46187

Machine B Year 0 1 2 3 4 5 Cash Flow (14500 0) 50000 51500 49450 43500 43000 Discount Factor (7%) 1.000 0.935 0.873 0.816 0.763 0.713 Total NPV= NPV() (145000) 46750.0000 44959.5000 40351.2000 33190.5000 30659.0000 50910

The company takes the decision to invest in Machine B as it shows higher NPV (46,187) than Machine A (50,910).

From the Comparison Table and the Real Life Example it is evident that NPV is providing the most consistent and appropriate ways to analyse whether investing into a project or number of projects of a business would be profitable or not. It covers almost all the vital points to evaluate an investment decision although challenges exist in fixing the suitable rate for the cost of capital i.e. the discount rate.

Bibliography: 1. Steven, Grahame. "PERFORMANCE OPERATIONS." Financial Management (14719185) (November 2010): 38-42. Business Source Complete, EBSCOhost (accessed February 28, 2011). 2. Module Handbook, ACC1130, Managerial Finance, Part 2. 3. Module Handbook, STX 1120, Quantitative Methods for Financial Business 4. Weetman,Pauline. MANAGEMENT ACCOUNTING, Chapter 11.