Question

Principles of Finance II

WEEK 2: Discussion Prompt #1

After watching the following video, discuss NPV and IRR in terms of conflicting rankings and the theoretical and practical strengths of each approach.

https://www.youtube.com/watch? v=6RztxNwerOA

Answer 1

While ranking project NPV and IRR give confliction results because for any project with both positive and negative cash flows during the tenure of the project there can be multiple IRRs which can create confusion with regards to chhosing the appropriate IRR . In other case there might be no IRR.In some cases IRR might favour projects of smaller scale and reject projects of larger scale.However NPV provides correct ranking irrespective of timing of cash flow, (whether there is positive or negative cash flow over the time period) or the scale of the project.

Thgeoretical and practical strengths of the NPV and IRR: For selection of a project NPV shopuld be greater than 0 and IRR should be greater than WACC or required rate of return.Both give similar results in case of accepting or rejecting a project. However for ranking a project NPV is better than IRR. NPV gives the increase in the value to the firm. IRR states whetherit will increase or decrease the value of firm but can't give details of the magnitude of the increase or decrease in value.

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