Capital Budgeting Methods.
There are two methods of analyzing the viability of an investment:
a) Traditional methods
Pay back period method
Accounting rate of return method
b) Modern methods (Discounted cash flow techniques)
NPV – Net present value method
IRR – Internal rate of return method
PI – Profitability index method
For the above two (a & b) methods to be used, they have to meet the following:
i) They should rank ventures available in the investment market according to their viability i.e. they should identify which method is more viable than others.
ii) They should rank a venture first if the venture brings in return earlier and in large lumpsums than if a venture brought in late and less inflows over the same period.
iii) Should rank any other projects as and when it is available in the investment market. Such methods should take into account that all returns (inflows), must be cash returns as it is necessary to be able to finance the cost of the venture.