Question

1) What are the main differences between the NPV method and the IRR?

2) When does IRR give you the wrong answer?

3) How does the MIRR avoid the IRR shortcomings?

Please answer all sections with 5-7 sentences for each question.

Answer 1

1) NPV method refers to Net present value of cash inflows and outflows, it is calculated by reducing the present value of cash outflow from present value of cash inflow at the cost of capital of the project. A positive NPV means the project can be undertaken as inflows are more than outflows in terms of present value. IRR is the internal rate of return it is the rate where the Net Present value of a project is zero. It is the base rate, any return above IRR is considered to be profitable for the project.

2) In case where there is single outflow at the start of the year, there would be one single IRR but when the project has multiple cash outflows at different stages than the project will not have one single IRR there would be multiple IRR for a project, In that case we would not be able to decision whether to accept or reject the project based on the IRR

3) Where a project has multiple outflows IRR would not give us correct decision. Hence in that case project manager can use the MIRR method for decision making which would overcome the shortcomings of multiple IRR.