# NPV, IRR, MIRR, Pay Back

You need to get a better understanding of a new plant construction project. You call the financial analyst working on the project and ask ask her to bring the financials to you to discuss the valuation methodologies. Discuss three key valuation methodologies that companies use-- NPV, IRR, and MIRR.

Include a discussion of pay back as one of the valuation methodologies in addition to NPV, IRR and MIRR. The discussion should include different viewpoints regarding each of these four valuation methodologies.

Please include references in order to continue the research

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#### Solution Preview

Net Present Value (NPV) is defined as the present value of the future net cash flows from an investment project.

Net Present Value Formula is: NPV = PV (present value) less I (investment)

The net present value analysis eliminates the time element in comparing alternative investments. The NPV method usually provides better decisions than other methods when making capital investments. Consequently, it is the more popular evaluation method of capital budgeting projects.

When choosing between competing investments using the net present value calculation you should select the one with the highest present value.

NPV > 0, accept the investment.

NPV < 0, reject the investment.

NPV = 0, the investment is marginal.

The most critical decision variable in applying the net present value method is the selection of an appropriate discount rate. Typically you should use either the weighted average cost of capital for the company or the rate of return on alternative investments. As a rule the higher the discount rate the lower the net present value with everything else being equal. In addition, you should apply a risk element in establishing the discount rate. Riskier investments should have a higher discount rate than a safe investment. Longer investments should use a higher discount rate than short time projects, similar to the rates on the yield curve for treasury bills.

Reference: http://www.wikicfo.com/Wiki/Net%20Present%20Value%20Method.ashx

IRR (Internal Rate of Return)

Often used in capital budgeting, it's the interest rate that makes net present value of all cash flow equal zero. Essentially, this is the return that a company would earn if it expanded or invested in ...

#### Solution Summary

Valuation Methodologies: NPV, IRR, MIRR, Pay Back for new plant construction project