Payback method demerits this method has its own

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Payback Method Demerits This method has its own limitations and disadvantages despite its simplicity and rapidity. Here are a number of demerits and disadvantages claimed by its opponents:- 1. It treats each asset individually in isolation with the other assets, while assets in practice cannot be treated in isolation. 2. The method is delicate and rigid. A slight change in the division of labour and cost of maintenance will affect the earnings and such may also affect the payback period. 3. It overplays the importance of liquidity as a goal of the capital expenditure decisions. While no firm can ignore its liquidity requirements but there are more direct and less costly means of safeguarding liquidity levels. The overlooking of profitability and over stressing the liquidity of funds can in no way be justified. 4. It ignores capital wastage and economic life by restricting consideration to the proje cts’ gross earnings. 5. It ignores the earning beyond the payback period while in many cases these earnings are substantial. This is true particularly in respect of research and welfare projects. 6. It overlooks the cost of capital which is the main basis of sound investment decisions. In perspective, the universality of the payback criterion as a reliable index of profitability is questionable. It violates the first principle of rational investor behaviour-namely that large returns are preferred to smaller ones. However, it can be applied in assessing the profitability of short and medium term capital expenditure projects. Accounting Rate of Return Method It is also known as Accounting Rate of Return Method / Financial Statement Method/ Unadjusted Rate of Return Method also. According to this method, capital projects are ranked in order of earnings. Projects which yield the highest earnings are selected and others are ruled out. The return on investment method can be expressed in several ways a follows: (i) Average Rate of Return Method Under this method we calculate the average annual profit and then we divide it by the total outlay of capital project. Thus, this method establishes the ratio between the average annual profits and total outlay of the projects. As per formula,
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227 Thus, the average rate of return method considers whole earnings over the entire economic life of an asset. Higher the percentage of return, the project will be acceptable. (ii) Earnings per unit of Money Invested As per this method, we find out the total net earnings and then divide it by the total investment. This gives us the average rate of return per unit of amount (i.e. per rupee) invested in the project. As per formula: The higher the earnings per unit, the project deserves to be selected. (iii) Return on Average Amount of Investment Method Under this method the percentage return on average amount of investment is calculated. To calculate the average investment the outlay of the projects is divided by two. As per formula: Here: Average Annual Net Income does not mean average Annual Cash-inflow Average Investment may be of the following: OR OR
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