Question

In: Finance

Please answer all: Why should we not solely use the IRR method to decide whether to...

Please answer all:

Why should we not solely use the IRR method to decide whether to invest in a project? What are the drawbacks (weaknesses) to the IRR method?
Name at least three capital budgeting alternatives that can be used in this situation, other than IRR. What are the drawbacks/weaknesses of each of these alternative methods?
What would be your recommendation to the Energy and Mineral Resources Ministry as well as its investors on the best process in deciding whether to invest in these projects?

Expert Solution

Sometimes when there are multiple negative cash flows in a project then the IRR method might give us multiple IRRs and then it will be diificult to judge which IRR should be considered while making the Capital Budgeting decesion.

Drawbacks:

1) Ignore the size of the project

2) Ignores reinvestment rates

Three capital budgeting alternatives

a) NPV

Drawbacks:

1) Difficulty in determining the required rate of return of a particular project

2) Ignores Opportunity costs

b) Payback period

1) Doesn't include Time Value of Money

2) Ignores cash flow received after Payback period

c) Discounted Payback period

1) Complex calculation if there are multiple negative cash flows

2) Ignores cash flow received after Payback period

Net Present Value method would be recommendation to the Energy and Mineral Resources Ministry as well as its investors on the best process in deciding whether to invest in these projects.

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