Investment Appraisal Methods

The payback period method calculates the time it will take for an investment to repay its initial outlay.
It is a straightforward and simple method, focusing on liquidity and short-term viability.
However, it doesn’t take into account any cash flows received after the payback period and disregards the time value of money.

Return on Investment (ROI) measures the percentage return from an investment.
It provides a simplistic understanding of the investment’s profitability and aids in comparisons of different investment opportunities.
A disadvantage is that it may not accurately reflect the long-term profitability, as it could be affected by certain short-term factors.

The Net Present Value (NPV) measures the profitability of an investment by deducting the present value of cash outflows from the present value of cash inflows.
It accounts for the time value of money, acknowledging that a pound today is worth more than a pound in the future because it could be invested to earn interest.
Provides a more accurate and robust analysis of an investment’s profitability. If the NPV is positive, the investment should be made.

The Internal Rate of Return (IRR) is the interest rate at which the NPV of an investment equals zero.
It represents the maximum return that a company could pay on the capital invested in the project without loss.
A higher IRR indicates a more attractive investment but, like the ROI, it does not consider the long-term profits of the project.

The Profitability Index (PI) is a ratio of the present value of future cash flows to the initial investment cost.
A PI greater than 1 indicates the investment is profitable, while a PI less than 1 suggests the investment might not cover its initial costs.
The PI can be beneficial for comparing profitability across multiple investment options.