NPV, IRR or the Payback period. What’s the preferred method in corporations in analyzing investments?
My short answer is two-fold: For one, most often not only one of the three is considered, but two or all three of them, because the information they give differs (more on this below). The second part of the answer would be that it can depend quite a bit on the preferences of the final deciding person/body. At my company NPV and pay back used to be by far the most important parameters. Recently, IRR has become the most important measure because of a shift in preferences, experience, understanding in the ultimate decision body.This is not right or wrong, as explained below, it is just different as long as you understand the numbers and what assumption they encompass.Pay back: Does not take into account when the money is paid or earned. It deals with the risk of the business in a very different way than NPV or IRR. Still, many companies have a pay back hurdle. They will not do an investment, if it takes longer than x years. That bar may be arbitrary, but it is one way to deal with uncertainty.NPV: Tells you the value that you create through the project, IF you execute it exactly as projected. Advantages: You understand easily how much value the project adds and you can compare it with others as it is an absolute value. Disadvantage: 1) It is an absolute value. The larger project always creates a higher amount, but is not necessarily better. 2) NPV is calculated by discounting with the WACC. The WACC is calculated with the Beta, which reflects the businesses’ risk. It does not reflect the execution risk. If the underlying business case is calculated very aggressively and the likelihood of meeting that business plan is low, that is not reflected in the DCF. 3) NPV by itself does not show you what the impact is if the cash flow is x% lower or project takes longer. For that, you need a sensitivity analysis.IRR: Advantage: Shows you the return in % and therefore you can compare between projects of different sizes. But taking on too many small projects with good IRR might be too much work. If all internal efforts are included, then that issue should be eliminated. Disadvantage: More difficult to understand what an increase implies. Increase from 12% to 15% might double the NPV (depending on the timing of the cash flows)!I hope this helps and does not add to the confusion. Yes, it is not a straight answer, but that is the world of valuation.
Can you give other methods of project valuation other than NPV, IRR, payback method and profitability index?
Project Valuation Using Real Options: A Practitioner's Guide: Prasad Kodukula
Which method do you prefer, NPV or IRR, and why?
First of all, to know about IRR( Internal Rate of Return) you must know about NPV (Net Present Value).NPV = Discounted Cash Inflow- Discounted Cash OutflowHere the word “discounted” refers to the time value of money i.e. get discounted the real money by the discount rate. But the question is what is the discount rate, right? Here in project appraisal (Project Analysis), discounted rate refers to the minimum amount of return you want to achieve from the business. It might be eitherHurdle Rate - (cost of capital + minimum your wish return i.e. opportunity cost)Only the cost of capital (In case you have no much of project available)Average rate of return of market or your industry ( Average return of Bank if you wish to open Bank)or anything else as per your assumption based on your circumstances.Mathematically,If you borrow $100 and need to pay $105 in 1 year period i.e. 5% is the cost of capital of your business. So, you may assume 5% is the discount rate. Let's assume you earn $110 by investing in some of the investment portfolios after 1 year. Here $5 ($110–$105) is regarded as EVA( Economic Value Added) and Present Value of $5 or the present value of $110 less $100 derives the NPV i.e $4.762 (104.762–100).But what is your return in the aforesaid example? Yes, of course, the rate of return is 10%. It is simple right. Actually, it is the Internal Rate of Return (IRR). simply it is a return on my investment.So, Think a little bit technically if you discount the cash inflow i.e. $110 by IRR i.e. 10% then you will get $100 which is discounted cash outflow. Now the difference is ZERO.That’s why NPV @ IRR is always ZERO.IRR is defined as the rate of return on which NPV Value is ZERO.Hope you will understand.Hence, IRR is considering about my own portfolio only whereas NPV is the overall consideration of the related firms/ business. Hence, Most of the people consider NPV is more powerful than IRR but condition is always applicable.Thank you.
Which valuation method does Gordon Miller prefer - NPV or IRR?
The advantage to using the NPV method here is that NPV can handle multiple discount rates without any problems. Each cash flow can be discounted separately from the others. Another situation that causes problems for users of the IRR method is when the discount rate of a project is not known.I prefer good only cash flow. I focus on 1x revenue or 5x-7x free net cash flow.
Help with capital budgeting methods?
Hi here are the results -------Project S---Project L NPV-----$814.33 ---$1,675.34 IRR------15.24%------14.67% MIRR---13.77%------13.46% PI--------1.08 ------1.07 PBP----3 yrs and 5 mo.---3 yrs and 5 mo. DPBP--4 yrs and 7 mo.-- 4 yrs and 8 mo. Even though the Projec L has a higher NPV doesn't mean we should accept L The IRR and MIRR for Project S is higher than that of Project L thus making Project S more attractive The Profitability Index for Project S is higher than that of Project L thus making project S more attractve The discounted payback period for Project S is smaller than that of Project L thus making Project S more attractive
Explain net present value and internal rate of return methods in business finance?
how would you explain the different rankings given by the net present value and internal rate of return methods? when referring to a companies cash flows and finances.