Week 3 Peer Responses Business & Finance homework help

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Directions

Peer Response

Within business, working professionals should become comfortable receiving and giving constructive feedback. Critical analysis of topics, and providing and receiving constructive feedback, is important in one’s professional growth and development and a core competency for leaders. You will be expected to read the initial posting of at least ONE peer or instructor, and then provide constructive criticism to their peers’ initial postings. You should highlight strengths as well as opportunities for improvement:

1. Point out what you perceived to be the strengths of the initial posting along with supporting rationale.

2. Identify specific opportunities for improvement with regard to the content in the initial posting. Furthermore, you should provide supporting rationale for your stated position, as well as concrete suggestions and guidance intended to strengthen the effectiveness of the content.

Each response should be a minimum of 250 words

Directions

Peer Response

Within business, working professionals should become comfortable receiving and giving constructive feedback. Critical analysis of topics, and providing and receiving constructive feedback, is important in one’s professional growth and development and a core competency for leaders. You will be expected to read the initial posting of at least ONE peer or instructor, and then provide constructive criticism to their peers’ initial postings. You should highlight strengths as well as opportunities for improvement:

1. Point out what you perceived to be the strengths of the initial posting along with supporting rationale.

2. Identify specific opportunities for improvement with regard to the content in the initial posting. Furthermore, you should provide supporting rationale for your stated position, as well as concrete suggestions and guidance intended to strengthen the effectiveness of the content.

Each response should be a minimum of 250 words

Esther Colvin

NPV (Payback Rule)

     For this assignment, I chose to report on the NPV vs Payback rule.  Capital budgeting decisions are among the most important decisions a business owner or manager will ever make. Which assets to invest in, which products to develop, which markets to enter, whether to expand – these are decisions that literally make the difference between success and failure. Businesses employ an array of methods to help make such decisions. Among the most popular are the net present value method and the payback period method (What Are Capital Budgeting and Capital Structure? n.d., 2022).

     Under the net present value (NPV) method, you examine all the cash flows, both positive (revenue) and negative (costs), of pursuing a project, now and in the future. You then adjust, or “discount,” the value of future cash flows to reflect what they’re worth in the present day.  NPV makes this adjustment using a “discount rate” that takes into account inflation, the risk of the project and the cost of capital – either interest paid on borrowed money or interest not earned on money spent to pursue the project. Finally, it adds up the present values of all the positive and negative cash flows to arrive at the net present value, or NPV. If the NPV is positive, the project is worth pursuing; if it’s negative, the project should be rejected. When deciding between projects, choose the one with the higher NPV (What Are Capital Budgeting and Capital Structure? n.d., 2022).

     Under the payback period method, estimate how much it will cost your business to launch the project and how much money it will generate once it’s up and running. Then calculate how long it will take the project to “break even,” or generate enough money to cover the startup costs. Companies using the payback period method typically choose a time horizon – for example, 2, 5 or 10 years. If a project can “pay back” the startup costs within that time horizon, it’s worth doing; if it can’t, the project will be rejected. When deciding between projects, choose the one with the shorter payback period (What Are Capital Budgeting and Capital Structure? n.d., 2022).

     As we examine the pros and cons of each method, let’s review the payback method. The payback period method has some key weaknesses that the NPV method does not. One is that the payback method doesn’t take into account inflation and the cost of capital. It essentially equates $1 today with $1 at some point in the future, when in fact the purchasing power of money declines over time. Another is that the payback method ignores all cash flows beyond the time horizon – and those cash flows may be substantial. Big moneymakers, after all, sometimes take a while to get going (What Are Capital Budgeting and Capital Structure? n.d., 2022).

     On the other hand, the big drawback of the NPV method lies in its assumptions. If you don’t get your estimate of the discount rate correct, your calculation will be off – and you won’t know it until the project turns into a big money-loser (What Are Capital Budgeting and Capital Structure? n.d., 2022). 

     Many businesses use a combination of methods when making capital budgeting decisions. You could use the payback period method to narrow down options, then apply the NPV method to identify the best of the remaining projects. Or you could use the NPV method to separate the “winners” from the “losers” among possible projects, then look at payback periods to see which projects return their costs more quickly (What Are Capital Budgeting and Capital Structure? n.d., 2022).  NPV (Net Present Value) is calculated in terms of currency while Payback method refers to the period required for the return on an investment to repay the total initial investment. Payback, NPV and many other measurements form several solutions to evaluate project value (Wilkinson, J. (2021, July 24).

     Payback method, vs NPV method, has limitations for its use because it does not properly account for the time value of money, inflation, risk, financing, or other important considerations. While NPV method considers time value, and it gives a direct measure of the dollar benefit on a present value basis of the project to the firm’s shareholders. NPV is the best single measure of profitability (Wilkinson, J. (2021, July 24).

     Payback vs NPV ignores any benefits that occur after the payback period. It also does not measure total incomes. An implicit assumption in the use of payback period is that returns to the investment continue after payback period. Payback method does not specify any required comparison to other investments or investment decision making. It indicates the maximum acceptable period for the investment. While NPV measures the total dollar value of project benefits. NPV, payback period fully considered, is the better way to compare with different investment projects. If you’re looking to sell your company soon, download the free Top 10 Destroyers of Value whitepaper to learn how to maximize your value (Wilkinson, J. (2021, July 24).

     In conclusion, to answer the question on whether the NPV rule be more appropriate to use, let’s examine this.  Such a project exerts a positive effect on the price of shares and the wealth of shareholders. So, NPV is much more reliable when compared to IRR and is the best approach when ranking projects that are mutually exclusive. NPV is considered the best criterion when ranking investments (Corporate Finance Institute., 2021).  Net present value uses discounted cash flows in the analysis, which makes the net present value more precise than of any of the capital budgeting methods as it considers both the risk and time variables (https://www.facebook.com/thebalancecom (Links to an external site.)
., 2021).

References

Wilkinson, J. (2021, July 24). NPV vs Payback Method • The Strategic CFO. The Strategic CFO. https://strategiccfo.com/npv-vs-payback-metho/#:~:text=NPV%20(Net%20Present%20Value)%20is (Links to an external site.)

What Are Capital Budgeting and Capital Structure? (n.d.). Small Business – Chron.com. https://smallbusiness.chron.com/capital-budgeting-capital-structure-65174.html (Links to an external site.)

Corporate Finance Institute. (2021). NPV vs IRR – Overview, Similarities and Differences, Conflicts. Corporate Finance Institute. https://corporatefinanceinstitute.com/resources/knowledge/valuation/npv-vs-irr/ (Links to an external site.)

https://www.facebook.com/thebalancecom. (2021). Net Present Value (NPV) in Capital Budgeting. The Balance Small Business. https://www.thebalancesmb.com/net-present-value-npv-as-a-capital-budgeting-method-392915

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