making investment decisions.

the three main investment decisions and the advantages and disadvantages corresponding to each one.

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  • Investment Decisions
    • Payback Period
      • the time it takes for a project to repay its initial investment
      • advantages
        • easy to understand the results
        • Simple and easy to calculate
      • Disadvantages
        • ignores cash flow after the payback has been reached
          • does not look at overall project return
        • takes no account of the time value for money
        • may encourage short term thinking
        • ignores qualitative aspects of a decision
    • Average Rate of Return
      • looks at the total accounting return for a project to see if it meets the target return
      • Advantages
        • provides a percentage return which can be compared with a target return
        • focuses on profitability- a key issue for shareholders
      • disadvantages
        • does not take into account cash flows- only profits
          • may not be the same thing
        • takes no account of the time value of money
        • treats profits arising late in the project in the same way as those which might arise early
    • Net Present Value
      • calculates the monetary value now of the projects future cash flows.
      • Advantages
        • reflects the time value of money, with earlier cash flows more important to decision
        • looks at cash flows of all the projects
        • has a decision making mechanism,- reject projects with a negative NPV

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