When two projects compete for the same money, how do you decide which one is worth it?
Soda Pressed (a fictional soft-drinks business, run by entrepreneur Fizzy Rascal) has £250,000 to invest. It can fund one of two projects, not both. Each project would run for four years.
Its forecast net cash flows are largest in the first two years, then tail off as the equipment ages.
Forecast Net Cash Flows for the Project
Its forecast net cash flows start small while the new range builds an audience, then grow strongly in the later years.
Forecast Net Cash Flows for the Project
For each project you will work out three measures, with the steps guided and checked as you go:
Then you will judge which project Soda Pressed should back, and why.
The company, projects and net cash flows here are illustrative and fictional, designed so the three methods can be compared cleanly. Figures are rounded to keep the arithmetic clear. The 10% discount rate is the yearly return Soda Pressed has decided it needs from an investment. Example data, as of May 2026.
The payback period is how long it takes for a project's net cash flows to add up to the £250,000 invested. A shorter payback usually means lower risk, because the money is recovered sooner. When the £250,000 is reached partway through a year, take the amount still needed at the start of that year, divide it by that year's net cash flow, then multiply by 12 to turn the fraction into months. At AQA, payback is normally given in years and months.
| Year | 1 | 2 | 3 | 4 |
|---|---|---|---|---|
| Net cash flow (£) | 175,000 | 100,000 | 50,000 | 25,000 |
Add the net cash flows up year by year until they reach £250,000:
| End of year | 1 | 2 | 3 | 4 |
|---|---|---|---|---|
| Running total (£) | 175,000 | 275,000 | 325,000 | 350,000 |
The total passes £250,000 during Year 2. After Year 1 the total is £175,000, so £75,000 is still needed. Year 2 brings in £100,000, so the share of Year 2 needed is 75,000 ÷ 100,000 = 0.75 of a year, and 0.75 × 12 = 9 months.
Payback = 1 year and 9 months.
| Year | 1 | 2 | 3 | 4 |
|---|---|---|---|---|
| Net cash flow (£) | 50,000 | 75,000 | 125,000 | 175,000 |
| End of year | 1 | 2 | 3 | 4 |
|---|---|---|---|---|
| Running total (£) | 50,000 | 125,000 | 250,000 | 425,000 |
The running total reaches exactly £250,000 at the end of Year 3.
Payback = 3 years and 0 months.
ARR turns a project's returns (its net cash flows) into a percentage that can be compared with a target. The steps are: add up the four years of net cash flows, take off the £250,000 invested to get the total return, divide by 4 for the average annual return, then show that as a percentage of the money invested.
Project A: 175,000 + 100,000 + 50,000 + 25,000 = 350,000 in. Total return = 350,000 − 250,000 = 100,000. Average annual return = 100,000 ÷ 4 = 25,000. ARR = 25,000 ÷ 250,000 × 100 = 10%.
Project B: 50,000 + 75,000 + 125,000 + 175,000 = 425,000 in. Total return = 425,000 − 250,000 = 175,000. Average annual return = 175,000 ÷ 4 = 43,750. ARR = 43,750 ÷ 250,000 × 100 = 17.5%.
Money in the future is worth less than money today, because today's money could be earning a return. NPV shrinks each year's net cash flow back to its value today using a discount factor, then takes off the £250,000 invested. A positive NPV means the project adds value at the chosen 10% rate.
| Year | 1 | 2 | 3 | 4 |
|---|---|---|---|---|
| Discount factor at 10% | 0.909 | 0.826 | 0.751 | 0.683 |
Present value each year = net cash flow × discount factor.
Total present value: £ — (fills in once the four boxes are right)
Present value each year = net cash flow × discount factor.
Total present value: £ — (fills in once the four boxes are right)
Project A: 159,075 + 82,600 + 37,550 + 17,075 = 296,300. NPV = 296,300 − 250,000 = £46,300.
Project B: 45,450 + 61,950 + 93,875 + 119,525 = 320,800. NPV = 320,800 − 250,000 = £70,800.
Here are your three measures for the two projects. Read across each row and work out which project does better on that measure.
| Measure | Project A bottling upgrade | Project B new drinks range |
|---|---|---|
| Payback period | 1 year 9 months | 3 years |
| ARR | 10% | 17.5% |
| NPV (at 10%) | £46,300 | £70,800 |
Look closely. The three measures do not all point to the same project. One project looks stronger on how quickly the money comes back; the other looks stronger on the size of the returns and on value in today's money.
That disagreement is the whole point. Each method measures something different, which is why a business looks at more than one before deciding. Next, you make the call yourself.
Soda Pressed can fund only one project. Which would you back? There is no single right answer, but a strong recommendation names the trade-off rather than just picking the biggest number.
Each method is useful, and each has a blind spot. A sound decision uses all three together and then looks beyond the numbers.
Fizzy has made his call: Soda Pressed will back Project B, the new drinks range. His reasoning is that the new range is worth more in today's money (NPV £70,800 against £46,300) and earns the higher average annual return (17.5% against 10%), and it fits his plan to grow the brand.
He is clear about the trade-off he is accepting: the £250,000 is tied up longer because B does not pay back until Year 3, and the later net cash flows depend on the new range catching on. He is comfortable with that because Soda Pressed has enough cash to wait and he trusts the forecasts. As he puts it, a business that was short of cash, or less sure the range would sell, could sensibly choose Project A instead for its faster payback and lower risk. The figures inform the decision, but the judgement depends on the firm's aims and situation.
The skill here is not to crown whichever project wins the most methods. It is to understand what each measure captures and weigh it against the firm's situation: