● Payback period: The payback period calculates the length of time required to recoup the original investment. Payback periods are typically used when liquidity presents a major concern.
● Internal Rate of Return: The internal rate of return (or expected return on a project) is the discount rate that would result in a net present value of zero. An IRR which is higher than the weighted average cost of capital suggests that the capital project is a profitable endeavor and vice versa. The IRR rule is as follows:
○ IRR > Cost of Capital = Accept Project
○ IRR < Cost of Capital = Reject Project
● Net Present Value: The net present value approach is the most intuitive and accurate valuation approach to capital budgeting problems. Discounting the after-tax cash flows by the weighted average cost of capital allows managers to determine whether a project will be profitable or not.
