Question

How would you decide between two capital project choices if the different analysis methods (NPV, IRR, etc.) were pointing to different options? What are the relative strengths and weaknesses of each? Original posts should contain a minimum of 120 words, and at least one response with a minimum of 40 words should be made to a classmate's post.

Answer 1

Net present value of a project is the potential change in the investors when caused by that project while time value of the money is being accounted for it equals the present value of net cash inflows generated by a project less than the initial investment of the project net present value of a project is the potential change in investors wealth caused by the project if equals the present value of net cash inflows generated by a project it is one of the most reliable measures used in capital budgeting because it accounts for time value of money by using discounted cash flows in the calculation net present value calculation takes the following two things projected net cash flows in successive periods for main project at target rate of return that is the hurdle rate.

Accounts for time value of money which makes it sounded approach than other investment appraisal techniques which do not discount future cash flows search payback period and accounting rate of return. Net present value is even better than some other discounted cash flow techniques that is IRR in situations where the IRR . In situations where IRR and net present value give conflicting desicions.NPV should always be perfered.

Net present value is after all the estimation it is sensitive to changes in estimates for Anshul cash flows Salvage value and the cost of capital net present value do not take into account the size of the project for example se project A requires initial investment of dollar 4 million to generate net present value of Dollar 1million while competing project B requires Dollar to million investment to generate and net present value of Dollar 0.8 million if rebase a decision on net present value alone we will prefer project or because it has higher net present value.

The internal rate of return is used to measure and compare the profitability of various business projects and investment the internal rate of return is the common measurement used by Business lenders to decide which project will yield the greatest results in the form of return on investment let's say a company has three separate projects to evaluate and the business lenders of the company do not know which project will get the highest profit each project has the same cost of capital that is the financing cost so the higher the internal rate of return for the project the more the profitable the project will be assuming all other risks and factors are equal business leaders will only accept a project if the internal rate of return is above the cost of capital of the project and then reject the project if the internal rate of return is below the cost of capital.

One of the advantages of using internal rate of return is that the method provides the exact rate of return for each project as compared to the cost of investment the internal rate of return does allows the investors to get a sneak peek into the potential returns of the project before it begins the internal rate of return also considers the time value of money which is the measure of future earning potential of money this makes the process of evaluating returns more accurate incredible finally the concept of internal rate of return is easy to understand and the calculations are simple.

The disadvantages of internal rate of return is that the method does not consider important factors like project duration future cost of the size of the project the internal rate of return simply compares the project cash flows to be projects existing cost excluding these factors a multiple internal rate of return problem occurs when the cash flows during the project lifeline is negative this is known as non normal cash flow and such cash flows will give multiple internal rate of return. Net present value and internal rate of return method produce conflicting rankings when a project is an independent project meaning the decision to invest in a project is independent of many of other projects both the net present value internal rate of return will always give you the same result as a rejecting or accepting a project when net present value and internal rate of return are useful Matrix for analysing mutually exclusive projects that is when the decision must be one project or another these metrics do not allow always points you in the same Direction This is a result of timing of cash flows for each project in addition conflicting results may simply offer because of project sizes.