Which methods are used in capital budgeting to evaluate projects?

Which methods are used in capital budgeting to evaluate projects?

• A. Payback Period, Internal Rate of Return, and Net Present Value methods
• B. Payback Period only
• C. Internal Rate of Return only
• D. Net Present Value only

Answer: (A)

Capital budgeting relies on multiple metrics to gauge a project's merit, not just a single figure. The Payback Period gives a quick sense of liquidity by showing how long it takes to recover the initial investment; it’s simple, but it ignores any cash flows after payback and doesn’t account for the time value of money. The Internal Rate of Return estimates the rate of return the project earns by finding the discount rate that makes the net present value zero; it incorporates the timing of cash flows and helps compare to a required return, though it can be tricky with unusual cash flows. The Net Present Value measures the total value created by discounting all cash flows at the cost of capital and subtracting the initial outlay; a positive NPV means the project adds wealth. Because each metric highlights a different aspect—how quickly money is recovered, the profitability rate, and the overall value created—they’re used together in evaluating projects. That’s why listing all three methods captures the full range of information practitioners rely on.

Capital budgeting relies on multiple metrics to gauge a project's merit, not just a single figure. The Payback Period gives a quick sense of liquidity by showing how long it takes to recover the initial investment; it’s simple, but it ignores any cash flows after payback and doesn’t account for the time value of money. The Internal Rate of Return estimates the rate of return the project earns by finding the discount rate that makes the net present value zero; it incorporates the timing of cash flows and helps compare to a required return, though it can be tricky with unusual cash flows. The Net Present Value measures the total value created by discounting all cash flows at the cost of capital and subtracting the initial outlay; a positive NPV means the project adds wealth.

Because each metric highlights a different aspect—how quickly money is recovered, the profitability rate, and the overall value created—they’re used together in evaluating projects. That’s why listing all three methods captures the full range of information practitioners rely on.