20 November 2009
The internal rate of return on an investment or potential investment is the annualized effective compounded return rate that can be earned on the invested capital. IRR is given preference over NPV while making investment decisions and accordingly investment having high IRR is always pereferred.
In modern world, investments are done by using bank financing and not by investing own funds.
In this case, why should we look at IRR since there is no cash outflow in the first year.
In my openion we should not calculate IRR and should alway look at discounted cashflow for the purpose of making investment decisions.
20 November 2009
I support your opinion in the way that IRR assumes that all the immediate earnings are to be reinvested atleast at IRR while NPV method assumes that all the immediate earnings will be reinvested atleast at the cost of funds borrowed (Kd). Therefore, in case Cost of borrowed funds is more than IRR, our results could be misleading. Also, NPV give us the results in absolute/monetary terms as compared to relative terms (%) in IRR.
21 November 2009
I also support the above but with restriction dependint the life of project .
NPV good for 2-4 years planning but for going long i.e > 5 years scope for voltatlity in actual discount rate is higher now we decide our focus whether short or go long
So I prefer IRR for long range project for two basic reasons : -
1.Stake holder who invested must want to know the real rate return on investment they invested throughout the life of project not + or - as by NPV
2. Current Voltality in inflation rate for almost all inputs put severe pressure to know what we earned instead what we presumed the discount rate - which is not known.
Appreciate your response but as you know now a days projects are mostly funded through bank financing and there is no/ very less equity contribution. In this case, on which investment shareholders will look for the return? For them the venture which gives maximum returns in value terms is the best.
Any NPV is calculated only for the long term investments, viz 5 years or more, to see the present value of future inflows.
In accounting books still we have questios which gives cash outflows in first year and then inflows and then we see the project which give the highest compounded rate of return (IRR) for making decision. But practical senario is different.
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