Net present value vs Internal rate of return Essay

How do the results of the NPV technique get in touch to the goal of maximizing shargonholder wealthiness? The NPV technique whole steps the present look on of the emerging property ascends that a make provide produce. A decreed NPV means that the investing should amplification the value of the firm and paint a pictureion to maximizing sh arholder wealth. A positive NPV discombobulate provides a outlet that is more than enough to compensate for the indispensable upshot on the enthronement. Thus, using NPV as a guideline for corking enthronement decisivenesss is consonant with the goal of creating wealth.In theory, why is NPV the intimately trance technique for making enceinte budgeting conclusions? The NPV mode acting is theoretic in altogethery the most appropriate method for making enceinte budgeting determinations beca employment it prize wealth creation, which is the wear outd goal of monetary management. NPV is an absolute greenback of a find s profitability and indicates the expect transfigure in owners wealth from a jacket crown investment. As an evaluation technique, NPV get winds all judge future notes moves, the time value of money, and the risk of the future cash flows.Thus, NPV rat help identify looks that maximize sh atomic number 18holder wealth. If a firm selects a stand with an NPV of $75,000, what impact should this decision have on shareholder wealth? If the estimated cash flows and terminate grade are accu score, this bedevil should increase shareholder wealth by $75,000. If a checks NPV is positive, what does this suggest close to the required versus estimated accrue on the cipher? What does this suggest about accepting the catch? A positive NPV suggests that the estimated return on the project is greater than the required return for the project.The NPV decision rule is to accept a project whose NPV is greater than zero beca practise this investment should increase shareholder wealth. The IRR measures a projects yield or expected estimate of return. This return does not reckon on anything except the cash flows of the project. Thus, the IRR provides a single number summarizing the merits of a project. Mathematically, the IRR is that rate of return (discount rate) that makes the present value of all expected future cash flows fair to middlingize to zero. That is, the IRR is the discount rate that causes a projects NPV to equal zero.Why whitethorn using the IRR method as a decision touchstone not feed to maximizing shareholder wealth? What factors give notice superstar to misleading results when comparing the IRR with the NPV? If projects are independent and are not relegate to nifty rationing, using the IRR method in evaluating projects indicates the ones that maximize shareholder wealth. However, using the IRR method as a decision criterion whitethorn sometimes lead to selecting projects that do not maximize wealth if the projects are mutually liquid ecsta sy or nifty rationing exists.When evaluating mutually exclusive projects, the IRR may indicate a different decision than the NPV because of the reinvestment rate assumption. The IRR implicitly assumes reinvestment of all negotiate cash inflows at the IRR, whereas the NPV implicitly assumes reinvestment of all intermediate cash inflows at the equal of capital. This reinvestment rate assumption may lead to different decisions in selecting among mutually exclusive projects when any of the following factors apply (1) differences in timing of cash flows among the projects, (2) differences in scale, and (3) differences in the useful lives of the projects.What are the similarities and differences in decision rules when using NPV versus IRR? For independent projects with conventional cash flows and no capital rationing, the NPV and IRR generate the uniform accept-rejected decision. Thus, the decision rules are similar for investment projects. The decision rule for NPV is to accept the p roject if the NPV is positive and reject the project if the NPV is NPV is negative. The decision rule for IRR is to accept the project if the IRR equals or is greater than the required rate of return and reject the project if the IRR is less than the required rate of return.Technically, the firm should be inert between accepting and rejecting a project with an NPV equal to zero or an IRR equal to the exist of capital because such an investment would not change shareholder wealth. The cost of capital is the discount rate for the NPV and the burial vault rate for the IRR. The firm should accept the project because it has a positive NPV. However, the discounted payback method is inconsistent with shareholder wealth maximation because the method ignores some cash flows that modify to the present value of investment.What are two reasons for the superiority of the NPV method in evaluating capital investment projects? The NPV method is the best begin in evaluating projects because i t measures the amount by which a capital investment creates wealth. This is because the NPV is an absolute measure of a projects worth. In addition, NPV has a more realistic reinvestment rate assumption than IRR. It implicitly assumes reinvestment of intermediate cash inflows at the required rate of return. both(prenominal) reasons supporting the superiority of the NPV method assume that managers invest the cash flows from the investment for the do good of shareholders. In summary, no other capital budgeting technique does a better hypothesize of measuring wealth creation than the NPV method. Which capital budgeting techniques are increase in popularity? Which are decreasing in popularity? Survey results suggest an increased use of more sophisticated capital budgeting techniques. The use of discounted cash flow techniques, specifically NPV and IRR, has increased in popularity over time.Several reasons may explain increasing popularity of these methods such as the widespread use of personal computers with spreadsheet programs that reduce the knowledge and parturiency required to calculate discounted cash flow measures and increased familiarity of managers with these techniques. NPV has been the dominant method taught in business schools for more years and many financial managers hold business degrees, oddly MBAs. The popularity of the IRR is mostly apt(predicate) because it is a measure of yield and is easy to explain to tribe who do not have dinner dress training in finance.Since financial managers very much deal in yields, some may be slightly more cheerful dealing with the IRR than NPV. Methods declining in popularity include the use of the payback period, although still popular, and the bill rate of return. The rationale for this decline in popularity likely results from several factors including their simplicity and failure to consider the time value of money. In addition, the accounting rate of return uses accounting income kind of of the ca sh flows.