Where the management has to rank the investments, wth the objective of giving priority to the most rewarding ones, te investment with the highest NPV must be ranked first. Calculating Internal Rate of Return (IRR) is another method extensively used in the investment appraisals. IR is a rate where the cost of investment, csh outflow, i equal to the cash inflows. Te proposal with the highest IRR is considered to be the most rewarding one. Pyback period is another method utilized in investment appraisal which calculates the by the investment to generate enough cash inflows to recover the initial cost of the investment.
Ivestment appraisal through NPV method and IRR method are both very useful in order to financially attractive prospective of any investment decision. Agood financial analysis is based on the trade off between these two methods. Hwever, pactically the IRR method is used widely in investment appraisal decision. Te prime reason behind selecting the IRR method of appraisal is it is comparatively straight forward and can be used without having a prior experience in NV method has certain drawbacks and limitations.
Dfferent projects must be assessed at different discount rates because the risk for each project is generally different. Te reliability of the NPV based investment appraisal can be as reliable as the discount rate itself. Hwever, i practice, i is very unrealistic to determine different discount rate for different investment proposals. Wereas, IR uses a single discount rate to evaluate every investment, de to which it is used extensively among the financial analysts. sperior to the IRR method. IR method of is evaluating the financial result of an investment over a short period of time.
Mreover, IR is also ineffective for investments proposals which are a mixture of positive and negative cash flow. Fr these types of investments, te IRR can be more than one. Aother factor which makes the NPV method more reliable than the IRR method is the fact that the discount rate changes several time over the period. Te IRR method does not incorporate this fact into calculation, ad thus is not suitable for long term appraisal. I method the discount rate is known and is singular which makes it easier to evaluate the feasibility of the investment.
A investment with a negative value represent an. ..
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