Which capital budgeting technique is better--NPV or IRR? Is the assumption of reinvestment of cash inflow...

Which capital budgeting technique is better--NPV or IRR? Is the assumption of reinvestment of cash inflow beneficial for NPV or IRR? Which technique is preferred in real practice and why? Feel free to expand on your answers

Expert Solution

The capital budgeting technique which amongst NPV and IRR is better ,

NPV is better. NPV, discounts each cash flow separately. IRR needs to be compared to the discount rate to determine weather the IRR of the project is good or not. The NPV analysis does not require a discount rate. If the IRR > discount rate, then the project is feasible. NPV can also be sued for projects , where a project's discount rate is not known.

NPV does not have any reinvestment rates, the IRR does.The IRR has a reinvestment rate assumption that assumes that the company will reinvest cash inflows at the IRR's rate of return for the lifetime of the project.

It is beneficial for the IRR, which makes the bad projects look better and the better ones look great .

In the real world the NPV is preferred, NPV takes into account Time Value of Money. NPV gives priority to project profitability and it's risk factors. If there are two or more mutually exclusive projects, where we have to reject one of the projects in order to accept the other, then in that case too IRR is not effective.

jeff jeffy answered 1 year ago

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