Question

Explain the limitations or short comings of the NPV (Net Present Value) measure and compare them to the IRR (internal rate of return) measure. Which measure is better and why?

Answer 1

Limitations of NPV measure and comparing them with IRR

• NPV might not give you accurate decision whike comparing the two projects of unequal life - IRR method would be helpful here
• In most cases, NPV will not give a clear sense on how long a project or investment will generate positive NPV due to its simple calculation.- IRR method would not be helpful here
• NPV method fails to suggest at what period of time you will achieve positive NPV. - IRR method would not be helpful here
• Calculating the appropriate discount rate for cash flows is difficult with the NPV method - IRR method would be helpful here

Limitations of IRR measure:

• If the discount rate changes every year, IRR method fails to give results
• IRR method mighty result in more than 1 IRR which makes it harder to compare two projects.

Considering multiple factors, NPV measure is better becuase the NPV method uses a reinvestment rate close to its current cost of capital,.

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