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NPV:
Strengths:
*By considering the time value of money, it allows consideration of such things as cost of capital, interest rates and investment opportunity costs. It's especially appropriate for long-term projects
*The strength of calculating NPV is that we are recognizing the value of a dollar today is greater than the value of a dollar received a year from now. That's the time value of money concept. The other strength of this measure is that it recognizes the risk associated with future cash flow. It's less certain.
*Its strengths consist of the wide-scale acceptance of the measure in the financial community, and it's also based on discounted cash flows. The measure also recognizes the time value of money. When used properly, the measure provides excellent guidance on a project's value.
*Resulting number is easy to interpret: shows how wealth will change if the project is accepted./ Acceptance criteria is consistent with shareholder wealth maximization. /Relatively straightforward to calculate
Weaknesses:
*Ranking investments by NPV doesn't compare absolute levels of investment. NPV looks at cash flows, not at profits and losses the way accounting systems do. NPV is highly sensitive to the discount percentage, and that can be tricky to determine
*The weaknesses of the NPV approach are related to the measure's simplicity. Our NPV rule tells us to accept all investments where the NPV is greater than zero. However, the measure doesn't tell us when a positive NPV is achieved. Does it happen in five years or 15?
*Another limitation of the NPV approach is that the model assumes that capital is abundant; that is there is no capital rationing. If resources are scarce, then the analyst has to look carefully at not just the NPV for each project they are evaluating, but also the size of the investment itself. Fortunately, there is another measure that can help overcome this weakness: The calculation of internal rate of return
*Requires knowledge of finance to use./ An improper NPV analysis may lead to the wrong choices of projects when the firm has capital rationing - this will be discussed later.
IRR:
Strengths:
* It provides a simple hurdle rate for investment decision-making. It's the method favored by many Accountants and finance people, possibly the ones at your company.
Weaknesses:
* It's not as easy to understand as some measures and not as easy to compute (even Excel uses approximations). Computational anomalies can produce misleading results, particularly with regard to reinvestments.
*Ignores the size of the project.
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∙ 12y ago
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Why is the NPV approach often regarded to be superior to the IRR method?
Why is the NPV approach often regarded to be superior to the IRR method?
IRR VS NPV?
IRR: Internal rate return NPV: Net present value Both are measure of the viability of a project(s) You can have multiple IRR (because of discontinued cash flows) but you always have one NPV.
What are the advantages of IRR over NPV?
Elyse Douglas.
The NPV assumes cash flows are reinvested at the?
The NPV assumes cash flows are reinvested at the: A. real rate of return B. IRR C. cost of capital D. NPV
Why is npv better than irr?
NPV measures the return a project generates against the costs borne to generate them, while also considering Time Value of Money. Whereas IRR measures returns alone and is hence seen as a myopic metric. NPV will be positive only when the IRR>WACC (i.e. the returns are more than the costs). The concept of IRR being greater than WACC is also called 'Positive EVA'. Needless to say, a project must be selected when NPV > 0! When choosing between projects, the spread between IRR & WACC will determine the financial feasibility ...the higher the better.
Why NPV is better than IRR in capital rationing situation?
NPV measures the return a project generates against the costs borne to generate them, while also considering Time Value of Money. Whereas IRR measures returns alone and is hence seen as a myopic metric. NPV will be positive only when the IRR>WACC (i.e. the returns are more than the costs). The concept of IRR being greater than WACC is also called 'Positive EVA'. Needless to say, a project must be selected when NPV > 0! When choosing between projects, the spread between IRR & WACC will determine the financial feasibility ...the higher the better.
How do you make capital budgeting?
by considering npv analysis , irr and pay back period
What are TWO formula most directly associated with Budgets and cash flow forecasts?
irr and npv
If the opportunity cost of capital for a project exceeds the projects IRR then the project has a NPV negative?
If the opportunity cost of capital for a project exceeds the Project's IRR, then the project has a(n)
How does the reinvestment rate assumption affect the NPV versus IRR conflict?
Apparently the NPV and IRR are methods to obtain capital budgets. The reinvestment rate assumption affects both methods because it is what determines now much incoming cash flow is reinvested into project.
What are the problems of investment decision techniques?
NPV criterion, pay back criterion, best approach and IRR
Under what case IRR is preferred to NPV?
IRR is measured in terms of %age and not in absolute measures. It is the breakeven discount rate and is preferred where management is interested in evaluating the project in terms of %age. It enables the management to compare it to the inflation rate, cost of capital or investment and with other accounting ratios. If NPV or absolute return is same in large and small investment, then IRR method is preferred in choosing the investment. Because in this case, IRR gives the %age of return and a project with higher IRR is recommended.
