NPV, IRR, ARR and payback

Question 1

What are the advantages of NPV?

Answer 1

1) Takes time value of money into account
2) Shows total value added to the business

Question 2

What are the disadvantages of NPV?

Answer 2

1) Requires accurate cost of capital estimate
2) Can be harder to explain to non-financial managers

Question 3

What are the advantages of IRR?

Answer 3

1) Considers time value of money
2) Gives a clear percentage return which is easy to compare to targets

Question 4

What are the disadvantages of IRR?

Answer 4

1) Can produce multiple results with non-conventional cash flows
2) Doesn’t reflect project scale or absolute value

Question 5

What are the advantages of Payback Period?

Answer 5

1) Simple to understand and calculate
2) Focuses on liquidity and early risk recovery

Question 6

What are the disadvantages of Payback Period?

Answer 6

1) Ignores cash flows after payback
2) Doesn’t consider time value of money

Question 7

What are the advantages of ARR?

Answer 7

1) Easy to calculate using accounting data
2) Allows comparison with target returns or other projects

Question 8

What are the disadvantages of ARR?

Answer 8

1) Ignores time value of money
2) Based on profit not cash flow, which can be less reliable