Discuss the relative merits of using the NPV over IRR. Why is one favored over the other? Under what circumstances would one use the MIRR? Which is your preferred technique and why? Explain.
NPV is defined as the difference between an investment's market value and its cost. It is only a good investment if it makes money for the company so a positive NPV will be needed. Following steps have to be followed:
- Cash flows of the investment project should be forecasted based on realistic assumptions.
- Appropriate discount rate should be identified to discount the forecasted cash flows. The appropriate discount rate is the project's opportunity cost of capital.
- Present value of cash flows should be calculated using the opportunity cost of capital as the discount rate.
Net present value should be found out by subtracting present value of cash outflows from present value of cash inflows. The project should be accepted if NPV is positive (i.e., NPV > 0).The projects can be ranked from the most positive NPV to the lowest to determine profitability. NPV is most acceptable investment rule for the following reasons:
- Time value ...
600+ words, with references, explain why NPV is favoured over IRR.