Question

23. Does the Payback Period, Discounted Payback Period, NPV, IRR, PI ratio and MIRR given you the same accept/reject decision. Discuss the limitations of the methods that give you a decision different than that of the NPV.

Answer 1

All these might give different results as compared to NPV.
Weakness of Pay Back Period
1. doesn’t consider cash flows after Payback period.
2. It does not include time value of money.

Weakness of Discounted Pay Back Period
1. doesn’t consider cash flows after Payback period.

Disadvantages of IRR
1. Is not good for acceptability with large scale projects where it might be rejected when comparing with small scale project if IRR is higher.
2. IRR and NPV may conflict in certain case where NPV rule Prevails.
3. IRR rate is higher than WACC generally so reinvestment as higher than WACC may not be possible always.
4. It gives multiple IRR when have more than one negative cash flows occur in the project

Disadvantages of PI
1. It doesnot give actual increase in the value of firm due to undertaking a project as it is a ratio.

Disadvantages of MIRR :
1. It doesnot quantify the increase in value of firm due to undertaking a project.
2. The discouting rates and reinvesting rates are subjective and can create confusion