Question

Pyramid Printing Company’s Controller, Sally Sound, and the Production Manager, Darrell Dailey, once again discuss potential operational improvements. After successfully implementing JIT and subletting the warehouse space, Pyramid was flush with cash. As a result, Darrell inquired whether it was time to purchase another press. Henry Hines, Pyramid Printing’s Sales Manager, suggested that the market be tested to ensure the press would be full in terms of capacity prior to use.

Sally and Darrell then discuss their choice of decision model; Sally prefers net present value, and Darrell prefers internal rate of return. Consider the use of these models. Which model is better for use? Are there circumstances one must consider regarding the outcomes of these two decision models? Do these models both deliver the same level of accuracy for decision making? Please provide detailed information with refference

Answer 1

In many cases, we must consider NPV as a better model when compared to the IRR as it provides the same accuracy level for decision making

Net Present Value (NPV) and Internal Rate of Return (IRR) are used in the evaluation process for capital expenditure.

The difference between NPV and IRR are given below:

The NPV calculates in dollar value with respect to a project whereas IRR creates the percentage return that the project is expected to create.

The NPV method concentrates on project surpluses whereas IRR is concentrate on the project's breakeven cash flow level.

The NPV method presents an outcome which forms the foundation for an investment decision.It is useful for decision making since it shows profit.The IRR method does not assist in making this decision, since its percentage return does not show the investor how much money will make.

The estimated rate of return for the reinvestment of intermediate cash flows is the firm's cost of capital when NPV is used whereas it is the internal rate of return under the IRR method.

The Net Present Value method requires the use of a discount rate. In the case of IRR, the rate of return is simply derived from the normal cash flows.

NPV is the best approach because it is easily understandable and acceptable compared to IRR Method