NPV and IRR are two of the most important decision criteria in capital budgeting. Will NPV and IRR methods always yield the same accept/reject decision? Please elaborate and list one potential cause of ranking conflicts between NPV and IRR.
NPV and IRR are two of the most important decision criteria in capital budgeting. Will NPV and IRR methods always yield the same accept/reject decision? Please elaborate and list one potential cause of ranking conflicts between NPV and IRR.
Net Present Value
Net present value is the difference between the present value of the cash inflows and the present value of the cash outflows over a period of time. It is a method used in capital budgeting in order to determine profitability of a project
NPV= Rt/(1+i)t
where, NPV = Net present value
t= time of the cash flow
i= discount rate
Rt= net cash flow at the time
Internal Rate of Return
Internal rate of return is a rate of growth an investment is expected to generate over a period of time. It is a discount rate that makes the NPV of all cash flow equal to zero in a discounted cash flow analysis.
IRR=[Cash Flow/(1+r)t]- Initial investment
where, r= discount rate
t= time period
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