Internal Rate Of Return Essay

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Net present value (NPV) is used in capital budgeting to analyze the profitability of the project or investment. The internal rate of return (IRR) is annualized effective compounded rate of return. It is also described as the rate of return that makes all NPV of all cash flow from a particular project equal to zero. NPV is calculated regarding currency while IRR is expressed in percentage form, therefore, complicated. NPV takes into account the cost of capital while IRR doesn’t hence NPV makes it possible to evaluate capital employed into a particular project or investment. The IRR method cannot be used in the evaluation of projects where there are changing in cash flow, unlike NPV.IRR calculation is ineffective where the project has a mixture of negative and positive cash flow, but NPV is suitable in both situations. NPV considers the time value of the money, but this is not the case in IRR.NPV method calculates the additional wealth while IRR method does not. Applying NPV method using different discounts rates, it will give different recommendations, but IRR method provides the same recommendations hence NPV method is flexible. A cash payback method is a tool used to evaluate various capital projects and decide the best project to invest in.This method estimates how long an investment will take to cover …show more content…

Over the time, you might came across a project with negative and positive cash flows. When IRR is used, it gives multiple answers hence leading to wrong decisions. IRR doesn’t take into account the cost of capital hence it becomes difficult when comparing projects/investments over a specified duration. IRR overstates the annual corresponding rate of return for the projects whose short-term cash flows are reinvested at a lower rate than calculated IRR, which leads to poor

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