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Chapter 29, Profit, Net Return - Coggle Diagram
Chapter 29
Payback
This would be important because they would try and maximise the amount of profit by working out how long it would take to get back and this means they can estimate how much the business might make next year this is commonly used on dragons den
So if the net cash flow was 20,000 and you invest 30,000 and next year the net cash flow was 40,000 you would get your money back in 1 year and 3 months and that would be the payback on the investment
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It doesn't measure the amount of profit in the investment and there are no indications of the inflow or the outflow of the business or when the inflows will occur in order to make more educated decisions on business choices.
Advantages of payback would be that its a quick and easy method of working out the level of risk in the investment, the longer the payback the bigger the risk. Its also easy to calculate and easy to understand it puts emphasis on how quick the money will be paid back.
Net Present Value
Net present value is the only method that takes into account the deterioration in value that a product might have and then you have the information whether you invest or not depending on the value of money at the time.
One disadvantage of using net present value would be that its far more complex than payback or ARR and because its more complicated than them it takes more time and time is money in this industry. Its value as a decision making tool is limited by the fact of the discount factor which is a guess at most about the value of money over time.
An advantage of using net present value is that it takes into account the amount and value of money over time and all the cash inflows are accounted for which is better for payback.
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