Question

What are the best ways to evaluate investments. What is the best one and why?

Answer 1

Investment decision is an important decision taken by finance managers. They have to work towards maximization of the returns from the investment. There are many ways by which the company’s finance manager has to evaluate the investments. Some of the ways by which investments can be evaluated are:

a) Net Present Value

b) Internal Rate of Return

c) Profitability index

These techniques take the time value of money into consideration.

Some other techniques of evaluation of investments are:

a) Payback period

b) Average Annual Rate of Return

These techniques do not take time value of money.

The best technique for evaluation of investments is IRR or Internal Rate of Return. IRR is the rate at which the Net Present Value of the investment is zero. It gives the profitability of the investment throughout its lifecycle. It also takes into consideration the time value of money.