Capital Investments Evaluation Methods, Thesis of Marketing Management

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Comp 1/Module 2 - Reflection University of Phoenix ACCCB/543: Managerial Accounting and Legal Aspects of Business

Comp 1/Module 2 – Reflection Evaluating different potential capital investments is very important for managers today, especially with the exponential growth in technology integration into most process. These assets and accompanying solutions can vary drastically in scale and scope making selection much more difficult. Capital investments are long term operational assets making this process critical. One of the first considerations when evaluating capital assets is the time value of money. The current value of money today is less than that same money in the future. This is due to the investment opportunity of money, future risk of return, and normal inflation over time. Three methods that can be used to analyze investments are the net present value, internal rate of return, and the payback method. Each has its own advantages and disadvantages. Net Present Value Net present value (NPV) indicates the return on an investment. It is calculated by subtracting the total cost of an investment from the present value of future cash inflows it will generate. It is important to use the present value of the inflows since the value of that money will not be the same now as it is in the future. Generally, if the investment returns a positive number for the NPV it is a good investment and it should be rejected if a negative number is returned. This method is advantageous as it provides an actual estimation on total profit for an investment. It also directly accounts for the time value of money giving a more realistic forecast on profitability. An investment that would yield $100,000 per year over the next 2 years and a desired rate of return at 12% is worth $169,005 today. Assuming the investment cost less than that it is possible to approximate the profitability of the investment beyond the 12% desired return. However, when comparing two investments that both have positive results it can be misleading since larger investments will likely yield larger return but not necessarily at greater

will take for an investment to pay for itself. Investments with shorter payoff periods are typically better than those with longer payoff periods. The timeline of an investment is a very important factor in many cases and not directly accounted for in NPV and IRR. Two investments may yield the same rate of return and the same profit but the pay off period for one may be significantly shorter than the other making it the better investment. The downsides to this method are that it does not actually account for the rate or profitability meaning it may still be necessary to employ another method to further evaluate an investment, and it does not account for the time value of money.