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evaluate investments

I am writing a paper on how a company can evaluate investments and would like to know

1) Besides net present value(NVP) and internal rate of return(IRR), what other criteria do companies use to evaluate investments?

2) What are some disadvantages of NPV as an investment criterion?

3) How will a change in cost of capital impact an investment decision process?

Solution Preview

Apart from NPV and IRR, other techniques used for evaluating investments are:

1) Payback Period: The payback method is the simplest way of looking at one or more major project ideas. It tells you how long it will take to earn back the money you'll spend on the project. The formula is:

cost of Project/ annual cash inflow= Payback Period

Under the payback method of analysis, projects or purchases with shorter payback periods rank higher than those with longer paybacks. The theory is that projects with shorter paybacks are more liquid, and thus less risky ? they allow you to recoup your investment sooner, so you can reinvest the money elsewhere. Moreover, with any project there are a lot of variables that grow increasingly fuzzy as you look out into the future. With a shorter payback period, there's less of a chance that market conditions, interest rates, the economy, or other factors affecting your project will drastically change.

Generally, a payback period of three years or less is preferred. Some advisors say that if the payback period is less than a year, the project should be considered essential.

There are a couple of drawbacks to using the payback period method. ...

Solution Summary

Besides net present value(NVP) and internal rate of return(IRR), what other criteria do companies use to evaluate investments?

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