Evaluation Points

Question 1

What are the strengths of Accounting Rate of Return (ARR)?

Answer 1

• Simple and easy to calculate/ understand
• Very similar to ROCE
• Projects judged by ARR are assessed in the same way internally and externally

Question 2

What are some weaknesses of Accounting Rate of Return (ARR)?

Answer 2

• Attaches the same value to cash flows whether received in Y1 or Y5
• Should ARR be calculated before or after depreciation? before.
• Does not consider size of investment

Question 3

Strengths of Payback Period?

Answer 3

• Minimises impact of long-term risk - like change of govt
• Quick and simple to calculate/ understand
• Avoids difficulties in projecting cash flows

Question 4

Weaknesses of Payback PEriod

Answer 4

• Difficulties in predicting what expenditure has to be paid
• Ignores time value of money
• Favours short-term projects over long-term projects

Question 5

Strengths of NPV:

Answer 5

• Recognises the time value of money i.e. inflation
• Recognises difference in size of investment
• Allows for additivity (adding with other projects)

Question 6

Weaknesses of NPV?

Answer 6

• Difficult to explain to people not formally trained in finance
• Provides answers in monetary terms, so does not allow for comparison for profitabilty

Question 7

Weaknesses of CVP Analyisis?

Answer 7

• Doesn’t take into account the time value of money
• Assumes prices and variable costs stay the same (ignoring inflation)
• In practice it can be difficult to break down all costs into either fixed or variable