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Net Present Value (NPV) Versus Internal Rate of Return (IRR)
Net Present Value (NPV) Versus Internal Rate of Return (IRR)
Contents
TOC o “1-3? h z u The NPV approach to valuation is superior to the IRR approach. Suggest how you would approach getting buy-in from senior management. PAGEREF _Toc377396170 h 1Analyze the variation in the results of net present value and the internal rate of return for use in evaluating a combination of projects or portfolio of projects and how the variations should impact decision making. PAGEREF _Toc377396171 h 1Investments in Global Markets” Please respond to the following: (use article below) •From the e-Activity, analyze the factors that should be considered in determining the required rate of return for evaluating projects, in global markets and how this impacts decision making. PAGEREF _Toc377396172 h 3As CFO, discuss how you would defend the difference in the required rate of return for your company on similar projects in the Brazil and India PAGEREF _Toc377396173 h 4
The NPV approach to valuation is superior to the IRR approach. Suggest how you would approach getting buy-in from senior management.Net present value is equal to the sum of the present value of all cash flows associated with a project. The one outstanding feature of NPV is that it steadily decreases as the discount rate increases. Internal rate of return is the discount rate that equates the present value of cash inflows with the present value of cash outflows on investment. It is the rate of discount where the net present value is equal to zero (Siegel, 2008).
NPV is superior to IRR because it makes it easy to compare different projects. There is also the chance that consecutive projects can have their NPVs can be added together. This ensures that poor

projects with a negative NPV will not be accepted just because it is paired with a project with a positive NPV. IRR is not reliable because it is possible for one to obtain more than one solution for the same project, this means that a project can be accepted and rejected on different times under same conditions. IRR also overstates the desirability of short life projects over those that are longer. IRR also discriminates against projects that have large capital outlays especially if the projects being compared are mutually exclusive (Siegel, 2008).
Analyze the variation in the results of net present value and the internal rate of return for use in evaluating a combination of projects or portfolio of projects and how the variations should impact decision making.Suppose the cash flows of different time periods of a project are as follows and the cost capital r= 10%, then the NPV would be
Year Cash Flows
0 1000000
1 200000
2 200000
3 300000
4 300000
5 550000
NPV = -1000000 + 200000 +200000 + 300000 + 300000 + 550000
(1.1)0 (1.1)1 (1.1)2 (1.1)3 (1.1)4 (1.1)5
= -1000000 + 181818.182 +165289.256 + 225394.440 + 204904.037 + 341506.720
= 118912.643
Generally NPV is calculated by
= ? Ci – Bi
(1 +r)i
Decision rule is if NPV >0 the project is viable, accept project
NPV<0 the project is not viable, reject project NPV =0 the other factors apart from NPV should be considered. In our case accept the project. IRR = r + PV1 [ (r1 +r2)/ (PV1 + PV2)] Given the following figures, PV1 = 10000, r1 = 10, r2 = 20, PV2 = 5000 IRR = 10 + 10,000 (10/15000) = 16.7 There should be a predetermined discount rate that is r*= 15 Decision rule is IRR >r* then the project is viable and it should be accepted.
IRR