Npv vs Irr

Topics: Net present value, Internal rate of return, Discounted cash flow Pages: 3 (1090 words) Published: June 23, 2013
How do the results of the NPV technique relate to the goal of maximizing shareholder wealth? The NPV technique measures the present value of the future cash flows that a project will produce. A positive NPV means that the investment should increase the value of the firm and lead to maximizing shareholder wealth. A positive NPV project provides a return that is more than enough to compensate for the required return on the investment. Thus, using NPV as a guideline for capital investment decisions is consistent with the goal of creating wealth. In theory, why is NPV the most appropriate technique for making capital budgeting decisions? The NPV method is theoretically the most appropriate method for making capital budgeting decisions because it measure wealth creation, which is the assumed goal of financial management. NPV is an absolute measure of a project’s profitability and indicates the expected change in owners’ wealth from a capital investment. As an evaluation technique, NPV considers all expected future cash flows, the time value of money, and the risk of the future cash flows. Thus, NPV can help identify projects that maximize shareholder wealth. If a firm selects a project with an NPV of $75,000, what impact should this decision have on shareholder wealth? If the estimated cash flows and discount rate are accurate, this project should increase shareholder wealth by $75,000. If a project's NPV is positive, what does this suggest about the required versus estimated return on the project? What does this suggest about accepting the project? 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 because this investment should increase shareholder wealth.

The IRR measures a project’s yield or expected rate of return. This return does not depend on anything except the cash flows of the project. Thus, the IRR provides...
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