Capital Budgeting and Financial Investment Decision Making
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1. Which is the best tool for capital budgeting: NPV, IRR, or MIRR? Which of these three is best for financial investment decision making? Give specific examples where one is preferable to the other.
2. Which is best for financial investment decision making: NPV, IRR, or MIRR? Give specific examples where one is preferable to the other.
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Solution Summary
This solution discusses the best tool for capital budgeting when choosing between NPV, IRR, and MIRR. The best choice for investment decision making is given, along with specific examples of when one is preferable to another method. This solution also discusses the best tool for investment decision making, when choosing between the same methods.
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1. NPV is definitely the most commonly used method and the method of choice for managers, investors, and laypeople alike. The reason is that NPV creates a distinct advantage because it considers the time value of money and all relevant cash flows for the project. Through a net present value analysis, the cost of capital is then also considered so that management is sure that the project will provide the return that they are looking for. When we perform an NPV analysis, all projects that have a negative NPV are automatically rejected because it means that the company will, without any doubt, lose money on the investment. We never accept a project with a negative NPV.
We would use an NPV for almost any project. IRR is also used, but one of the main disadvantages is that IRR can't work when the streams of cash flows change in amount with the passage of time. Oftentimes in projects, we are working with more than one cash flow. We may receive a stream of cash from the project's first several years based on capital ...
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