Eddison Electronic Company

One of the advantages of NPV is that it does not assume reinvestment of the cash
flow. Thus, it is suitable for measuring a project’s profitability (Maravas & Pantouvakis,
2018). The Internal Rate of Return (IRR) is advantageous because of the time value of
money. The investment is likely to appreciate in the future because of inflation. However, it
ignores the economies of scale, thus not considering the actual value of a dollar. The payback
period is an easy tool to use in capital budgeting. However, it is disadvantageous because it is not
realistic and ignores the profitability potential of the investment made.
The Present Net Value is $608,057.82 when the cost of capital is 14%. The internal
rate of return is 21% and the payback period is 4 years. NPV is the best method that ECC
should use because it yields higher returns within a shorter period. If they were to use the
payback period, they would have to wait for four years to recoup the amount invested. And if
they decide to use the Internal Rate of Return, the figure is too high at 21% than the cost of
capital which is 14%. Since the NPV is more significant than one, then it is the most suitable
method to use.
When the cost of capital changes to 25%, the Present Net Value reduced to
$214,784.36. Thus, the most suitable method to use will be the payback period. It will not be
advisable to use the NPV as there is a depreciation in the amount compared to what was
initially invested as capital.
If ECC did not save $500,000 per year, the method to be used would change from
the payback period to IRR. Such is because the cash flow for each year will not be constant
as it will change. Therefore, instead of four years, it will take more to recoup the initial
investment, not advisable. The best solution will be to focus on the Internal Rate of Return.
The least amount of saving that will make the investment attractive to ECC is
$250,000. Such is because there is a reduction in the amount being invested per years by half,

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and the repayment period is equally going to reduce by the same amount. Thus, ECC will
have to wait for a lesser period for them to start realizing gains. The focus is to recoup the
initial capital within the least time possible.

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Reference

Maravas, A. & Pantouvakis, J. (2018). A New Approach to Study Net Present Value and
Internal Rate of Return of Engineering Projects Under Uncertainty with Three-
Dimensional Graphs. Journal of Advances in Civil Engineering, 6(1): 1-9.