Sample Essay on Using Multiple Methods in Evaluating an Investment Proposal

The use of multiple techniques in evaluating investment projects has significant advantages. The first advantage is that the use of multiple techniques provides a better analysis compared to when only one method is used. For example, the use of NPV and IRR together permits the determination of present value of future cash flows and the profitability of the project in percentage terms. Secondly, when dealing with mutually exclusive projects, it may be difficult to select a project when only one method is used. For instance, project X and Y may both have a high positive net present value. Consequently, the use of multiple techniques permits the evaluation of projects from different dimensions leading to the selection of the most viable project. Thirdly, the use of multiple techniques provides an almost perfect indication of a project`s value, its risk, and its contribution to stockholder wealth maximization, which cannot be achieved with a single method. For example, payback indicates the risk and liquidity associated with a project while NPV indicates the project`s profitability and wealth for shareholders. Fourthly, the strengths inherent in the use of multiple methods tend to offset the shortcomings of any single approach in the appraisal of investment projects, for example, the payback method gives the time period when the invested capital will recouped, but tells nothing about the time value of money. On the other hand, NPV gives the time value of money, but says nothing on when the investment will be recovered. As a result, when the two methods are used together, they address each other`s weaknesses while providing useful information that permits the best investment decisions to be made.Fifthly, methods such as IRR, PI and NPV give similar accept or reject decision when evaluating independent projects. As a result, multiple methods serve as a useful tool for confirming the viability of independent projects. Finally, the use of multiple methods allows for the evaluation of different investment projects that include: projects with conventional cash flows; with non-conventional cash flows; independent projects; and mutually exclusive projects that may otherwise be impossible to evaluate using a single method.

On the other hand, the use of multiple techniques in evaluating projects also presents significant disadvantages. Firstly, the use of multiple techniques results in significant complexities because different methods must be computed and analyzed for every project being appraised, which is costly in terms of time and requires specialized knowledge. Secondly, different methods may result in inconsistent results. For example, NPV and IRR may indicate that the project is viable and should be pursued, while other methods such as payback and profitability index indicate that the project should be rejected. Thirdly, with multiple techniques, there are numerous assumptions that have to be made in the evaluation of the proposed projects. Depending on the methods adopted, the assumptions made may negatively affect the choice of investment, especially where these assumptions are not based on reasoned judgment. For example, if the project cash flows are erroneous, the investment decision made may not be accurate. Fourthly, some of the disadvantages inherent in the individual methods are not offset even with the use of multiple methods. For example, NPV is difficult to use while IRR is hard to compute. Fifthly, when multiple methods are used in evaluating different projects, differences in the timing of project cash flows and differences in project sizes may give rise to conflicting results making it hard to determine which project to adopt. Finally, although certain methods may provide similar results, they may give different interpretations. For example, when profitability index and NPV are used, they produce similar results; however, they differ in one major aspect. Given that profitability index is a ratio;it offers no clue on the real cash flows and extent of investment.