--%>

Evaluation of net present value

Explain evaluation of net present value (NPV) and internal rate of return (IRR) in brief?

E

Expert

Verified

The evaluation of net present value (NPV) and internal rate of return (IRR) is well developed and documented in many publications, some representative ones of which are Muro’s and Lang and Merino’s. IRR and NPV are the most common and important indicators in investment decisions. Although ARR (accounting rate of return), as reported by Lefley, is also a common indicator, whose role was fully discussed by Brief and Lawson, both Muro and Lefley and Morgan opined that ARR has shortcomings and that the discounted cash flow methods, such as IRR and NPV, the so-called more “sophisticated” and “scientific” methods, should be preferred in capital investment appraisals.

Although IRR and NPV both are discounted cash flow methods, they have intrinsic differences from one another. Tang and Robinson and Cook illustrated that the ranking of investment alternatives is not necessarily the same obtained by the two methods. Differences in rankings between NPV and IRR are further exhibited in Asquith and Bethel, who reported that IRR might be preferred to NPV under certain circumstances. Evans and Forbes also reckoned that IRR is more cognitively efficient than NPV because IRR is expressed as a percentage (or a rate of return) while NPV was just a monetary value cognitively inefficient to decision makers, and hence the use of IRR should be promoted. Other researchers, such as Lefley and Morgan, and particularly the academicians, however, took the view that NPV is more conceptually “correct” despite the fact that the IRR is more popular than the NPV, and that NPV is more theoretically sound as the IRR may be too “capricious” or “fickle” and may not rank some projects in the same order as the NPV.

The definition is: IRR gives the private investor’s point of view and NPV the society’s point of view. In other words, the IRR is a financial indicator and the NPV, an economic indicator. Because the IRR functions as a financial indicator, its value varies with the change of financial arrangements (e.g. change of equityloan ratio, change of taxation rate, etc.) of a capital investment. The NPV, however, does not vary when financial arrangement varies, because it functions as an economic indicator. In this paper, the authors will use an illustrative example to show the basic differences of IRR and NPV. They will also show a mathematical proof to substantiate these intrinsic different natures of the IRR and the NPV.

   Related Questions in Macroeconomics

  • Q : Cost-push inflation Describe cost-push

    Describe cost-push inflation and its major source.

  • Q : Moentary policy a restrictive monetary

    a restrictive monetary policy is designed to shift the

  • Q : Market system The market system's

    The market system's answer to the fundamental question "How will the system promote progress?" is essentially:

  • Q : Taxing imports-whats the problem ‘Must

    ‘Must a country which is less proficient at generating all goods use import controls to decrease imports from additional countries?’

  • Q : Supply of foreign currencies into

    What are the main sources of supply of foreign currencies into domestic economy? Answer: A) Foreigners purchasing home country’s goods and services via exports. B) Foreign investment in home country via

  • Q : Price elasticity of demand for DVD games

    In this figure shown below, the price elasticity of demand for DVD games among prices of $30 and $40 is nearest to: (i) 7/6. (ii) 1/2. (iii) 3/7. (iv) 7/3. (v) 1/3.

    Q : Federal fiscal stimulus in 2009

    Question: Was the stimulus package passed in 2009 as success?  In answering this question the focus should be the articles on the syllabus, but you should also include opinions of other commentators. &nbs

  • Q : Surplus of the good Describe when there

    Describe when there will be a surplus of the good?

  • Q : Aggregate demand if government budget

    What occurs to aggregate demand if the government budget is in deficit? Answer: The deficit budget raises the aggregate demand since the deficit budget signifies th

  • Q : Paradox of Value-High values of

    The fact that most of the necessities for life like water are priced much lower than the frivolities like diamonds is addressed by the: (1) Utilitarian enigma. (2) Law of diminishing marginal utility. (3) Rational ignorance of hypothesis. (4) Paradox of the value. (5)