According to research, NPV and IRR are the most used methods of determining capi

Question

According to research, NPV and IRR are the most used methods of determining capital budgeting decisions. Discuss the positive and negative aspects of these and any other methods you deem relevant. Finally, state the method you would use as a financial manager and explain why. According to research, NPV and IRR are the most used methods of determining capital budgeting decisions. Discuss the positive and negative aspects of these and any other methods you deem relevant. Finally, state the method you would use as a financial manager and explain why. According to research, NPV and IRR are the most used methods of determining capital budgeting decisions. Discuss the positive and negative aspects of these and any other methods you deem relevant. Finally, state the method you would use as a financial manager and explain why.

Explanation / Answer

NPV IRR Advantages Advantages Consider Time Value of Money Consider Time Value of Money Takes into Account all the cash flows Takes into Account all the cash flows Considers risk of cash flows Considers risk of cash flows If the NPV is positive project is accepted as it will increase firms value. If the IRR isgreater than cost of capital then project is accepted as project will increase firms value Disadvantages Disadvantages Need to determine cost of capital to determine the rate at which cash flows need to be discounted. Estimating it is a tough task. Need to determine cost of capital in order to make a decision If the NPV is positive then project is accepted even though benefit is minmal It might not lead to perfect decision when considering mutually exclusive proposal. A project may have a higher IRR in comparison to other project but lower NPV. Thus it may be misleading in case of mutually exclusive projects Similarly may lead to misleading decisions in case of capital rationing

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