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Payback Period, Net Present Value, and Internal Rate of Return

Three of the most commonly used techniques for evaluating possible capital projects are the Payback Period, Net Present Value, and Internal Rate of Return. Discuss the strengths and weaknesses of each of these three methods. Which technique do you think is the best method? Be sure to justify your choice of the best method.

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The payback period is one of several techniques companies use for evaluating possible capital projects which indicates how long it will take to recoup the initial investment of the project. Prior to using this method, companies should be aware of its strengths and weaknesses. The main strength of the payback period is its simplicity. A company will determine the maximum number of years by which it wants the project to recoup the investment. Most companies will prefer a shorter payback period to minimize risk and therefore, the longer a project takes to recoup its cost, the higher the risk becomes of not recouping the cost at all. Another strength of the payback period method is it provides companies with a screening process when they need to decide among several projects. This is accomplished by first determining their maximum payback period and then eliminating each project with costs that would exceed the maximum payback period. On the other hand, a weakness of the payback period its disregard of money's fluctuating value. While some methods of evaluating capital allow businesses to consider the change in value over ...

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