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Paper Topic:

NPV Vs. IRR

NPV VS . IRR

2007

NPV VS . IRR

Introduction

The growth in particular business drives companies to expand their services and products in to acquire more customers while generating more profits . In turn , the objectives force the companies to select the best options when dealing with investment for product or service development

Deciding which investment options the companies should take is not an easy task since there should be a thorough appraisal so that the company takes appropriate decision and prevents further investment downfall

The amount of fund that

a company spends on a project depends on how much the project will provide return . For the reason , there are several considerations that a company must pay attention when conducting a project 's investment appraisal as following

Cost of capital or investment project

Estimated life of project / capital

Estimated net cash inflows from capital or project

Estimated residual value of project or capital

Taxation implications

Inflation and other related factors (Idowu , 2000

In to help companies decide which investment option should be taken , there are many investment appraisals tools such as payback period or average rate of return (ARR . However , in this , we will compare two most used investment appraisals : net present value (NPV , and internal rate of return (IRR

Investment Appraisals

Basically , there are two methods of capital investment appraisals conventional and discounted cash flow (DCF ) methods . The conventional method composes two types of calculation : payback period and average rate of return (ARR ) while discounted cash flow (DCF ) method includes three types of calculation : net present value (NPV , internal rate of return , and profitability index (PI

The two methods have both advantages and disadvantages . The conventional method is the fastest way for evaluating the capital investment but it lacks to consider the time value of money . Meanwhile , the discounted cash flow (DCF ) method , although it takes more time than the conventional method for evaluating the capital investment , the inclusion of considering the time value of money makes this method is the and accepted method . The reason is money has the time value so we should consider it in our evaluation of capital investment

Time value of money is basically the concept or terminology that describes that a dollar we received today is worth more than a dollar received at some point in the future . This is because the amount of dollar we receive today can be invested to earn interest and within a specific period of time , inflation exists that will reduce the value of money . Therefore , time value of money problems generally involves the relationship between a certain amount of money , a certain period of time , and a certain rate of compound interest . Although NPV and IRR both consider time value of money , they are comparable to find which one is the best for project appraisals ( Time Value

Net Present Value (NPV

Ganon (2005 ) says many traditional financial analysis techniques employed by managers such as payback period and return on investment fail to take the time...

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