Answer to Question #153791 in Finance for TAO YANG

Question

Why NPV is the preferred investment technology compared with ARR,IRR,Payback,

Answer 1

NPV is preferred over IRR, ARR and payback period because NPV uses preset values to calculate cash flows to get more realistic picture in term of time value of money. Whereas, IRR deals with breakeven point of the project and ignores cashflow after breakeven point and NPV covers total life of the project.

ARR refers to return on investment percentage. It shows at what is the percentage on return on total investment. It ignores the time value of money factor.

Payback period shows how much time the project will take to recover the investment in time i.e months, years. Payback period is calculated using both discounted and non-discounted cash flows but it doesn’t cover cash flows after recovering investment. 

So NPV is preferred over ARR, IRR and payback period as it shows realistic picture of cash flows using time value of money and it covers whole life of the project.