Reference no: EM132975422

Question 1: Why is the payback method so popular? NPV is clearly the best method, so why is it not more embraced as opposed to the IRR method?

Question 2: What makes the explanation easy (or difficult) to understand? Make suggestions on what you would include as well.

NOTE: "Capital budgeting is a financial strategy that aids in deciding which projects to take on that will add value to the company. Typically projects should be chosen that increase the companies profitability and the wealth of the shareholders. The three most common capital budgeting tools are the payback period, internal rate of return, and net present value. The payback period method is used to identify the amount of time it would take to generate enough cash from an investment to cover the cost of that investment. For example, if investing in a new factory costs $1,000,000, the company would use this method to find how many years it would take for the new factory to generate 1 million. This method is typically used for companies concerned with liquidity and want to know when they'll recover the investment to put the funds towards another project. The internal rate of return is a discount rate which the company compares to the cost of receiving the funds to invest in a project. If the IRR is higher than the cost of obtaining the funds for the project, then the project is worth accepting. Lastly is net present value, which interprets the stream of cash flows from an investment in today's dollars. Unlike IRR, which uses a benchmark to see if projects are worth taking, the NPV dives deeper. For example, the IRR might tell your company that only these three should be accepted of these five projects. But the NPV method would look at those three acceptable projects and determine the profitability of each so a decision can be made if, say, the company could only take on two projects."