Effective Application of Financial Concepts Essay

Effective Application of Financial Concepts - Essay Example Firstly, Project Alpha has the shortest payback period. This implies that it will take the project a shorter period of time to repay its initial investment out of the net cash inflow (Kinney & Raiborn, 2009: 555). The rest of the amount will be profit. Secondly, it has a higher ARR of 29.4% compared to merely 1.6% of the Beta project, making the investment more attractive. The Alpha project is, therefore, more profitable than the Beta project. Finally, Project Alpha has a higher NPV than project Beta. Project Alpha has more cash inflows than project Beta. Payback period is the time that a project takes to recover its expenditure or the amount of time required for a project to repay its initial investment amount out of its cash inflows (Atrill & McLaney, 2011, p.364). PP provides a measure of liquidity founded on the projects expected cash flows (Weingartner 1969: 594). When using payback period, companies normally base their decisions on a maximum time limit that is predefined for projects. A project with the shortest projected time is chosen (Atrill & McLaney, 2011). This method is more realistic because it uses cash flows and not accounting profit. It is simple to calculate and is more useful in situations where there is the rapid change in technology as well as improving investment conditions. Finally, the method favours quick returns by maximising liquidity, minimising risks and helping company growth. The greatest flaw of PP is that it fails to take into consideration the returns after the payback period. It ignores cash flow timings as well as overall project profitability. The method is subjective because it fails to give definite investment signal. Even though payback period gives high emphasis on liquidity, it ignores profitability. It also ignores cash flow after the payback period making it less effective in gauging a project. When using ARR, companies normally base their decisions on a predefined minimum target ARR for projects.  Ã‚