IRR, NPV, and accounting rate of return
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I. "It is a matter of indifference whether investment projects are selected by the internal rate of return method or the next present value method."
Discuss the circumstances in which this statement may not hold.
ii. Why cannot the accounting rate of return be used as a reliable capital budgeting technique? What are its advantages?
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Solution Summary
Response discusses the IRR, NPV, and accounting rate of return for capital budgeting techniques.
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The net present value (NPV) method offsets the present value of an investment's cash inflows against the present value of the cash outflows. If a prospective investment has a positive net present value (i.e., the present value of cash inflows exceeds the present value of cash outflows), then it clears the minimum cost of capital and is deemed to be a suitable undertaking. On the other hand, if an investment has a negative net present value (i.e., the present value of cash inflows is less than the present value of cash outflows), the investment opportunity should be rejected.
(principlesofaccounting, 2008)
Internal rate of return is the return at which present value of cash inflows are equal to initial investments. In other words, it is the interest rate that would cause the net present value to be zero. IRR is a ranking tool. The IRR would be ...
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