4. In order to incorporate fractional-year time periods within the payback framework, an important assumption that was made is that the timing of cash flows is assumed to be evenly distributed within the year. For instance, a 3. 25 payback period indicates that the initial investment would be recovered by the first quarter of year 4. This is assuming that the net cash flow in year 4 is not received by the third quarter of the year in lump-sum (in which case, the correct answer would be 3. 75) or assuming that the timing of NCF is evenly distributed.
In other words, the fractional-year corresponds to fractioning the NCF of a year and assuming the timing of cash flows to be consistent with the year. 7. Given the shortcomings of the IRR methodology, it still proves to be an accurate method to use in evaluating the project alternatives facing IEI. It measures the benefits or returns relative to the amount invested and does not give a fixed dollar amount of return, unlike NPV which is prone to error. IRR also discounts the cash flows unlike the undiscounted payback period.
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IRR also proves to be accurate because accdg. To this method, among the investment alternatives of IEI, only (c) or the combined project is acceptable because IRR>cc. This is consistent with the payback and NPV method where only c is acceptable as well. 8. (a)The undiscounted payback method ranks the alternatives according to which recovers the initial investment fastest (lowest payback period). The alternatives of IEI has payback periods that exceed n. In this case, the project with the smallest remaining unrecovered initial investment is ranked highest. b)Using the NPV method, projects with the highest NPV is ranked highest. (c)Using the IRR method, the investment with the highest IRR is ranked highest. A particular method would seem superior to the other two depending on the terms. For instance, in terms of time-consumed for computation, the payback method is superior to the other two. On the otherhand, the NPV proves to be superior to the other two because it discounts the cash flows unlike the payback and uses the cost of capital in assuming reinvestment which is a reasonable estimate as compared to the often high rate by the IRR.
In terms of practicality, IRR seems superior because it measures benefits relative to the amount invested as rates rather than actual dollar returns. In general terms, it is possible that either NPV or IRR is superior in terms of accuracy either theoretically or practically, respectively. IRR can possibly be suggested as superior to the other two because it discounts cash flows and because there are a variety of techniques in practice that are available for avoiding the pitfalls of the IRR.