When will IRR and NPV rule give you the same investment decision? When might IRR
ID: 2802284 • Letter: W
Question
When will IRR and NPV rule give you the same investment decision? When might IRR not exist or not be unique? What happens to the NPV as we assume very high or very close to zero discount rates?
What is in a discount rate? What is the risk-free rate? What is a risk premium?
What is the difference between idiosyncratic and systematic risk? What do investor’s demand compensation for? Why?
What is the diminishing marginal utility for wealth and how is it related to risk aversion?
Under the CAPM, What is the relationship between risk and return? How do we estimate risk premia? What is beta and how does it relate to expected returns? Why might firms differ in their betas? Can a firm or asset have negative beta? What is the market portfolio and can we observe it?
Explanation / Answer
1.
NPV and iRR are two measure of capital budgeting use to evaluate a project viability and acceptibility. NPV provides the present value of excess dollar value a project earn and IRR provide rate of return on investment. NPV assumes all cah flow are reinvested at cost of capital rate while IRR method assumes all cash flow reinvested at IRR rate which is not always true.
for a project has convention cash flow that is one cash outflow at begining of period and number of cash inflow in future then NPV and IRR provides similar result. if a project has non conevntional cash flow that is many cash outflow and many cash inflow then project provides miltiple IRR and in this case we should use NPV measure to evaluate project.
In NPV method if discount rate is very high then present value of future cash flows would be low and in this case NPV of project would also be low. again, if if discount rate is very low that is lose to zero then present value of future cash flows would be high and in this case NPV of project would also be high.
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