Compare payback, ARR, NPV and IRR
Match each appraisal method to what it measures and explain conflicting rankings.
Section 4.4 · Investment appraisal
Exam scope and assessment notes
Cambridge International AS & A Level Accounting 9706, 2026–2028 syllabus, Version 2. This topic covers future net cash flows, payback, ARR, NPV, IRR and supported investment decisions. Discounted payback and questions involving a residual value at the end of a project are excluded by Cambridge. Practice is self-checked, not an official Cambridge grade. Full timed Papers 1–4 and human subject-teacher review remain outstanding.
Before you begin
- Use AS Topics 1.5–1.6 for profit, depreciation and financial analysis, and Topic 2.1 for contribution. Keep accounting profit, project cash flow and the time value of money distinct.
Work on paper. Try each question before revealing help, and explain why your method works.
Quick readiness check
Which method uses accounting profit?
What you will learn
- Match each method with its measure
- Compare benefits and limitations
- Explain conflicting project rankings
Methods answer different questions
Payback measures how quickly initial cash is recovered. ARR expresses average accounting profit as a percentage of average investment. NPV measures present-value contribution at a chosen rate. IRR finds the rate at which NPV is zero.
Basic payback and ARR do not discount flows. NPV and IRR reflect time value but depend on cash forecasts and rates.
Use the objective to interpret results
Payback may address liquidity, ARR an accounting target, and NPV value at the required return. IRR gives a rate but can conflict with NPV for projects with different scale or timing.
When methods conflict, explain their different focus and use the objective, risk, cash constraints and supporting data to recommend.
Pause and explain
Which pair are the zero-NPV rate and value at a selected rate?
Worked example
A has shorter payback; B has higher NPV. Give a reason to choose B.
Show the worked solution
- Payback prioritises recovery speed.
- NPV includes discounted flows over the project life.
- If value creation is the objective and liquidity is adequate, B may be preferred, subject to risk.
Answer B may be preferred for higher NPV if cash constraints and other risks are acceptable; A only leads on recovery speed.
Try a topic test
Choose Easy, Normal or Difficult. Save your answers and open worked review after finishing.
Test this topic →From guided practice to a new situation
Write your answer and reasoning first. Use a hint only if you are stuck. The model solution is for self-checking; your written work is not automatically marked.
Payback favours A, but NPV favours B. Give a reason for each and one next check.
Give me a hint
Recall what each method counts.
Compare my reasoning
- A recovers initial cash sooner.
- B has greater discounted value at the chosen rate.
- Check forecasts, scale, liquidity and feasibility.
A leads on recovery speed; B on discounted value. Review forecast reliability and objectives before deciding.
Look for these in your work
- Payback interpreted
- NPV interpreted
- Next evidence named
A has payback 2 years, ARR 18%, NPV $6,000. B has payback 3 years, ARR 22%, NPV $11,000. Target ARR is 20%. Compare.
Give me a hint
Apply the target and state which measure each project leads.
Compare my reasoning
- A recovers sooner but is below the ARR target; NPV is positive $6,000.
- B meets the ARR target and has higher NPV but later recovery.
- Check liquidity, risk and constraints.
B leads on ARR and NPV; A leads on payback. Check whether later recovery is affordable.
Look for these in your work
- Methods compared
- Target applied
- Caveat retained
A manager reports only IRR because it is a percentage. What further result helps a mutually exclusive choice?
Give me a hint
Add total present-value contribution.
Compare my reasoning
- Calculate NPV for both at the same required rate.
- Compare scale and cash-flow timing.
- Include capacity and risk.
Show NPVs at a common rate, then explain scale and risk; IRR alone may rank projects differently.
Look for these in your work
- NPV added
- Common rate
- Context included
Common mistakes
- Treating methods as interchangeable
- Choosing only the result that supports a preferred project
- Ignoring objectives and funding constraints
What can you explain now?
Which method directly includes time value in a value total?
Compare with the explanation
NPV
NPV discounts future cash flows and compares them with the initial investment.
After trying it yourself, choose your next review. This is your self-assessment.
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Make it stick
What question does each appraisal method answer?
If you needed the solution, close it and solve the problem again from a blank page. A correct answer is stronger when you can explain the reason for each step.