Strenght and Weaknesses free essay sample

1. Prepare to discuss the strengths and weaknesses of the various measures of investment attractiveness as used by Euroland Foods. Will all of the measures rank the projects identically? Why or why not? i. Payback period: The advantage of the payback period: To some degree, we can say that the shorter the payback period, the less risk the investment is. So the measurement of the payback period takes into account of the risk of the investment. In addition, with the shorter payback period, you can recover your initial investment and can use your money to invest on other new projects. So it can help the company seek profitable investment opportunities in the changing market. The disadvantages of the payback period: It does not take into account of the time value of the money. It gives the equal weight to all the cash flow occurred in different time. With a greater inflation, the payback period may bring companies great loss. We will write a custom essay sample on Strenght and Weaknesses or any similar topic specifically for you Do Not WasteYour Time HIRE WRITER Only 13.90 / page The factor of the investment size is not included in the payback period. Even though a project has a short payback period, it may have a very small profit. In contrast, another project, with a big investment size and a relatively long payback period, is very profitable. The payback period does not give attention to the term structure. With the same payback period, two different projects may have dramatic lad in profitability. When to use payback period: According what mentioned above, it is better use payback period to make investment decisions when all the projects have no difference on other items and when the investor gives much importance to the recovery time. ii. The analysis of the IRR: The merit of this measurement is taking into account of the time value of the money and the term structure of the cash flow. It has strong links with NPV. We can easily see this correlation from its definition. NPV is an absolute value, but IRR is a relative value. So it can better reflect the efficiency of the investment. In other sides, the IRR has its own limitation. Firstly, it does not consider the size of the investment. Given a high IRR, if the scale of the investment is very small, there will be little attraction in that investment. Secondly, the investment risk rises when the investment has a long length. And if the payback period is long, to some degree it can lead to missing on likely new investment opportunity. When to use IRR: When all of the investment alternatives have the same size and length, we should use IRR as our criteria to choose the best project. iii. Minimum accepted ROR: The advantages of minimum accepted ROR: Compared with other measurements, the biggest advantage of minimum accepted ROR maybe is its convenience. There is no need to do the complex calculation about discount or other things. In practice, investors just need to compare the minimum accepted ROR with the practical ROR to make their choices. Disadvantages: Simplicity always takes hand with many inaccurate consequences. The minimum does not take into account any elements like time value, size of investment, length of investment and so on. So only when there are no many choices on other factors, we can take a short cut to use the minimum accepted ROR. iv. NPV: The assets of NPV are taking into account of the time value, the investment size and the term structure. The liabilities of NPV, It does not consider the impact of the investment length. A high NPV may means to trade off a long limitation on the use of the money. A long term also can result in a potential risk. v. Equivalent annuity: Equivalent annuity is not an unattached measurement. It is used as a compliment to some measurements. It corrects for differences in duration among various projects. In ranking projects on the basis of equivalent annuity, bigger annuities create more investor wealth than smaller annuities.