Internal Rate of Return (IRR) and Net Present Value (NPV) are both powerful tools used in business to determine whether or not to invest in a particular project; both methods have its pros and cons.

Topics: Net present value, Rate of return, Investment Pages: 3 (853 words) Published: June 30, 2004
Internal Rate of Return (IRR) and Net Present Value (NPV) are both powerful tools used in business to determine whether or not to invest in a particular project; both methods have its pros and cons. If given a choice I would choose NPV, because of the potential to anticipate profitability.

As it is assumed that the objective of a firm is to create as much shareholder wealth as possible for its owners through the efficient use of resources, the preferred method in determining whether or not to invest in a project is NPV. The reason for this is that NPV takes into account all the costs and benefits of an investment opportunity, making a logical allowance for the time factor. Generally speaking any appraisal that returns a positive NPV result is a worthwhile investment. This means finding the NPV of a business will have a direct bearing on shareholder wealth. Net present value is a way of comparing the value of money now with the value of money in the future. A dollar today is worth more than a dollar in the future, because inflation erodes the buying power of the future money, while money available today can be invested and grow.

There are two advantages NPV as a capital expenditure appraisal technique it accurately recognizes the time value of money for all expenditures, regardless of the exact time at which they are made or received it enables alternative proposals to be ranked in order of attractiveness it recognizes the time value of money by converting future expenditures and receipts to their corresponding present value on investment criteria, taking account of the exact date on which they are expected to be made or received.

There are two disadvantages to NPV as a method of appraising capital expenditure proposals the net present value requires the organization to calculate an interest rate to use for appraising capital investment proposals; the net present value calculation is only valid for the interest rate that has been used; the interest rate...
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