ECONOMICS

Detailed explanation-1: -The payback period method gives an estimate of the time period in which the entire investment in a project gets recovered without giving consideration to the time value of money. The internal rate of return is the discount rate for which the initial investment is equal to the sum of present values of future cash flows.

Detailed explanation-2: -KEY POINTS. Payback ignores the time value of money. Payback ignores cash flows beyond the payback period, thereby ignoring the “profitability” of a project. To calculate a more exact payback period: Payback Period = Amount to be Invested/Estimated Annual Net Cash Flow.

Detailed explanation-3: -NPV Method is the most optimum method for capital budgeting. Reasons: Consider the cash flow during the entire product tenure and the risks of such cash flow through the cost of capital. It is consistent with maximizing the value to the company, which is not the case in the IRR and profitability index.

Detailed explanation-4: -The specific time value of money calculation used in Capital Budgeting is called net present value (NPV). NPV is the sum of the present value (PV) of each projected cash flow, including the investment, discounted at the weighted average cost of the capital being invested (WACC).