Unformatted text preview: value over project life (23) Book rate of return book income
book value of assets The main problem with the book rate of return is that it only includes the annual depreciation charge and
not the full investment. Due to time value of money this provides a negative bias to the cost of the
investment and, hence, makes the return appear higher. In addition no account is taken for risk. Due to the
risk return trade-off we might accept poor high risk projects and reject good low risk projects.
The payback period of a project is the number of years it takes before the cumulative
forecasted cash flow equals the initial outlay. The payback rule only accepts projects that “payback” in the desired time frame.
This method is flawed, primarily because it ignores later year cash flows and the present value of future cash
flows. The latter problem can be solved by using a payback rule based on discounted cash flows.
Internal rate of return (IRR)
Defined as the rate of return which makes NPV=0. We find IRR...
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