What are the different methods used for evaluating capital budgeting projects?

What are the different methods used for evaluating capital budgeting projects?

The different methods used for evaluating capital budgeting projects include:

1. Payback Period: This method calculates the time required to recover the initial investment. Projects with shorter payback periods are considered more favorable.

2. Net Present Value (NPV): NPV calculates the present value of cash inflows and outflows over the project's lifespan. A positive NPV indicates a profitable project.

3. Internal Rate of Return (IRR): IRR is the discount rate that makes the NPV of a project equal to zero. It represents the project's rate of return and is compared to the required rate of return. Projects with higher IRRs are preferred.

4. Profitability Index (PI): PI is the ratio of the present value of cash inflows to the present value of cash outflows. A PI greater than 1 indicates a profitable project.

5. Accounting Rate of Return (ARR): ARR calculates the average annual profit as a percentage of the initial investment. Projects with higher ARR are considered more favorable.

6. Modified Internal Rate of Return (MIRR): MIRR adjusts the cash flows to assume reinvestment at a specified rate. It overcomes the limitations of IRR and provides a more accurate rate of return.

These methods help in assessing the financial viability and profitability of capital budgeting projects.