Managers deciding on the Payback period basis usually follow their own instinct and the overall risk appetite of an organization when analyzing a project based on the Payback period. Te payback period indicates that the Phoenix Oil PLC would be able to recover its initial investment after 6 years. Tis recovery would only be generated from the internal revenues generated from the commercial drilling of the oil in question. Aerage Rate of Return (ARR) provides an idea of a project’s worth and its profitability over its useful life. I usually calculated by dividing the initial investment by the annual expected profits.
Te relative merit of this technique is that it helps in meaningful comparison between similar companies. Tis measure is widely used around the globe it helps in easily assessing the overall business performance. Te general decision rule with respect to ARR is to accept a project if it’s ARR is more than the Cost of Capital. Bsides its merits, te technique has some drawbacks too. Oe of the major disadvantages of the ARR technique is that it based on profits rather than real cash flows.
Hnce the technique has the susceptibility of being manipulated by managers in order to present better results of the company (Crosson& Needles, 2008). Te ARR for the Falkland Alpha project is 7. Te decision whether to accept or reject the project in this case lies within the hands of the manager as it depends upon the risk appetite and the rate of return required by the investors of the company. I the Discount rate of 10% is the Cost of Capital the company; te project should not be accepted (Anderson et al, 2008).
Iternal Rate of Return, cmmonly mentioned as IRR, i a method used within capital budgeting in order to quantify and compare the profitability of investments. IR is generally the discount rate that makes the present value of all cash flows equal to zero i. te present value of outflows equal the present value of inflows. Hgher the IRR more would be the prospects of the considered project. Te basic rule is that if the IRR is higher company’s Cost of Capital, i should the accepted.
“he IRR represents the highest rate of return an investor could afford to pay without losing money, i all the funds to finance the investment were borrowed and the loan was repaid by application of the cash proceeds from the...
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