Final answer:
The NPV method calculates the present value of projected cash flows by discounting them back to the present, taking into account the time value of money. The AAR method calculates the average accounting profit as a percentage of the average investment, focusing on accounting measures.
Step-by-step explanation:
The Net Present Value (NPV) and Average Accounting Return (AAR) are both methods used in financial analysis to assess the profitability of an investment project.
The NPV method calculates the present value of projected cash flows by discounting them back to the present using a specified discount rate. It takes into account the time value of money and provides a measure of the overall value generated by the investment. A positive NPV indicates that the returns are greater than the initial investment and is considered favorable.
On the other hand, the AAR method calculates the average accounting profit as a percentage of the average investment. It focuses on accounting profit rather than cash flows and does not consider the time value of money. While it provides a simple measure of return, it may not accurately reflect the economic value generated by the investment.
In terms of choosing one method as better than the other, it depends on the specific context and objectives of the analysis. If the primary concern is the value generated by the investment over time and the time value of money is considered important, then NPV is a more appropriate choice. However, if the focus is on profitability based on accounting measures and the time value of money is not a significant factor, then AAR may be suitable.