Capital Asset Management and techniques of its evaluation - Essay Example

Although the calculation is easy to understand and simple, it still has its limitations. It ignores the benefits, or the lack of, that occur after the payback period and more importantly, the method ignores the time value of money. On the contrary The Net Present Value is an indicator of how much value an investment or project adds to the firm. The Net Present Value is a more reliable method of calculating the returns expected from investments as the method considers the time value of money. The Net Present Value compares the value of a dollar today to the value of that same dollar in the future, taking both inflation and returns into account.

The technique uses discounted cash flow approach in assessing the performance of an investment. A positive Net Present Value generated from a prospective project is a good sign and should be accepted On the contrary, a negative Net Present Value resulting from projects should be rejected because the cash flows will also be negative. As such, this technique seems more reasonable in determining the returns of investments. The Internal Rate of Return is the discount rate that delivers a Net Present Value of zero for a series of future cash flows.

As with the Net Present Value, this technique uses the discounted cash flow approach and is as widely used as the Net Present Value method. . It shows the discount rate below, which an investment results in a positive Net Present Value and above which an investment results in a negative Net Present Value. It's the break-even discount rate, the rate at which the value of cash outflows equals the value of cash inflows. Moreover, the Internal Rate of Return can be found without having to estimate the cost of capital.

Modified Internal Rate of Return is a similar concept to the conventional Internal Rate of Return. However, it is easier to calculate and does not produce multiple results, from irregular cash flows expected from a project, as compared with the latter. Of course the drawback of using Modified Internal Rate of Return is that it does not expect the generation of cash flows from its projects as predicted and its Net Present Value seems overstated. This is contrary to the use of Internal Rate of Return technique, since it assumes that cash flows generated from a project are reinvested within the project at the same rates of return, although they are often reinvested elsewhere within the business.

The Modified Internal Rate of Return can be calculated with the use of spreadsheet package or the use of a conventional calculator. Both methods give the same results, however, the latter is more tedious and is used mainly for academic purposes. This technique uses the Present Value of investments, followed by the compounded terminal cash flow of the return phase. This is possible for more complex investments, with investment phase that stretches over several periods.The results generated by this technique are lower than the conventional Internal Rate of Return method but also presents a more realistic approach in assessing projects.

Moreover, the technique uses the