Table of Contents
- 1 How would you compare two different projects using the net present value method?
- 2 What does the internal rate of return compare?
- 3 How do you compare projects with different lives?
- 4 What is the importance of IRR?
- 5 Which of the following is an advantage of using the NPV method to evaluate different projects?
How would you compare two different projects using the net present value method?
When comparing two or more projects, the one with the highest NPV is typically the best choice. So the simplest way to apply the net present value method to capital rationing is to determine the NPV of each project and then list them in order from highest NPV to smallest.
What does the internal rate of return compare?
The internal rate of return (IRR) is a metric used in financial analysis to estimate the profitability of potential investments. IRR is a discount rate that makes the net present value (NPV) of all cash flows equal to zero in a discounted cash flow analysis.
Should you use NPV or IRR to choose between the two projects?
If a discount rate is not known, or cannot be applied to a specific project for whatever reason, the IRR is of limited value. In cases like this, the NPV method is superior. If a project’s NPV is above zero, then it’s considered to be financially worthwhile.
How do you compare projects with different lives?
The equivalent annual annuity approach is one of two methods used in capital budgeting to compare mutually exclusive projects with unequal lives. When used to compare projects with unequal lives, an investor should choose the one with the higher equivalent annual annuity.
What is the importance of IRR?
Companies use IRR to determine if an investment, project or expenditure was worthwhile. Calculating the IRR will show if your company made or lost money on a project. The IRR makes it easy to measure the profitability of your investment and to compare one investment’s profitability to another.
Why do NPV and IRR select different projects?
Whenever an NPV and IRR conflict arises, always accept the project with higher NPV. It is because IRR inherently assumes that any cash flows can be reinvested at the internal rate of return. The risk of receiving cash flows and not having good enough opportunities for reinvestment is called reinvestment risk.
Which of the following is an advantage of using the NPV method to evaluate different projects?
Which of the following is an advantage of using the NPV method to evaluate different projects? The cash flows the current project has generated in the past.