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NPV and IRR

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Write a 350-word summary, in which you answer the following questions:

a. Besides net present value (NPV) and internal rate of return (IRR), what other criteria do companies use to evaluate investments?

b. What are the disadvantages of NPV as an investment criterion?

c. How will the change in cost of capital impact the investment decision process?

Thank you in advance.

Solution Preview

a. Besides net present value (NPV) and internal rate of return (IRR), what other criteria do companies use to evaluate investments?

The investment decisions of a firm are generally known as the capital budgeting, or capital expenditure decisions. Some concepts are better than others when it comes to reliability but all provide enough information to get the general scope of the investment. The five procedures that provide useful information are the Net present Value (NPV), the Payback Rule, the Average Accounting Return (AAR), the Internal Rate of Return (IRR), and the Profitability Index (PI). These procedures will help rank the projects from the greatest investment to the worst.

Other criterias

The payback rule is how long it takes to recover the initial investment. This rule does not involve discounting which means that time value of money is disregarded, it fails to consider risk differences, and an accurate cutoff period cannot be picked.
ARR is defined as an investment's average net income divided by its average book value. The projects can be ranked according to the excess of AAR compared to the target AAR. Once again, this is a flawed ...

Solution Summary

This discusses the pros and cons of NPV and IRR, impact of change in cost of capital on investment decision process

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