Among the 3 investment rules (Net present value, Internal rate of return, Payback period), which one...

Among the 3 investment rules (Net present value, Internal rate of return, Payback period), which one you personally prefer and why? (>80 words)

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Expert Solution

We prefer Net present value to Internal rate of return and Payback period.

The NPV measures the value of the project in today's dollar terms. NPV has a simple decision making rule with no subjectivity involved in it. If NPV is positive, we accept the project, else we reject the project.

There is subjectivity involved in Payback period decision making tool. One manager may accept a project if the payback period is, say, 3 years, while another manager may accept the project if the payback period is 2 years even though the cash flows are the same for both the managers.

IRR rule says if IRR > the cost of capital, we accept the project, else we reject.

However, a project with unconventional cash flows may have multiple IRRs. We cannot use IRR tool to make a decision in such cases.

In addition, if there are two mutually exclusive projects, then IRR rule may conflict with NPV rule. In such cases, we must go with NPV rule because it is superior to IRR rule.

jeff jeffy answered 1 year ago

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