Capital Investment Decision

Capital Investment Decision

There are three methods that the owner of my company can use to evaluate the feasibility of purchasing long-term equipment. First, the owner can use the payback period method. Notably, this method estimates how long a project takes before its original value is recouped by considering cash flows. The payback method is simple to use and understand, meaning anyone can use it comfortably (Warren et al., 2016). However, the technique is highly criticized for ignoring all the cash flows after recovering the invested money. Also, it is criticized for ignoring the time value of money, which is vital in assessing the value of a project in the current situation.

Accounting rate of return (ARR) is the second method that the company can adopt. It calculates the anticipated profits from an investment by expressing them as a percentage of capital invested. The yardstick for accepting a project using this method is selecting projects with higher rates of return (Christodoulou, 2016). The technique is easy to calculate and understand, and unlike the payback period method, it considers the cash flows from a project for its entire life. However, the technique is faulted for ignoring the time value of money.

The discounted cash flow method is the third method suggested for the company owner. It is based on the principle of getting the present value of future cash inflows and outflows. The method is divided into the net present value method and the internal rate of return. The net present value is the most common, and it discounts the future cash flows into present values to ascertain the feasibility of a project (Bora, 2015). The method is advantageous because, unlike the two methods that have already been covered, it considers the time value of money. Also, it accounts for the cash flows from a project for the entire project period. Despite being faulted for being challenging to compute and understand, the company selected the method because of its advantages.

References

Bora, B. (2015). Comparison between net present value and internal rate of return. International Journal of Research in Finance and Marketing, 5(12), 61-71.

Christodoulou, D., Clubb, C., & Mcleay, S. (2016). A structural accounting framework for estimating the expected rate of return on equity. Abacus, 52(1), 176-210.

Warren, C. S., Reeve, J. M., & Duchac, J. (2016). Financial & managerial accounting. Cengage Learning.

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You have been asked by the owner of your company to advise her on the process of purchasing some expensive long-term equipment for your company.

Capital Investment Decision

Give a discussion of the different methods she might use to make this capital investment decision.
Explain each method and its strengths and weaknesses.
Indicate which method you would prefer to use and why.