Net present value (NPV), payback period (PBP) and internal rate of return (IRR) approaches for a project evaluation

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H00112703 INTERNATIONAL BUSINESS MANAGEMENT FRIDAY 08TH MARCH 2012 C38FN 2012-2013 CORPORATE FINANCIAL THEORY WORDCOUNT: 2874 Abstract This essay will discuss the net present value (NPV), payback period (PBP) and internal rate of return (IRR) approaches for a project evaluation. It is often said that NPV is the best approach investment appraisal, which I why I will compare the strengths and weaknesses of NPV as well as the two others to se if the statement is actually true. Introduction To start of, the essay will attempt to explain the theoretical rationale of the net present value approach to investment appraisal as well as its strengths and weaknesses. From there, introduce the payback period method and then internal rate…show more content…
The positive aspect of it using cash flows is that it determines when the project will earn its incomes, how soon they will come as well as how sizable they are going to be. What is meant when he states that it uses all the cash flows is that it acknowledges every single cash flow, regardless of the date or the size. The advantage for the shareholders of the firm is that it shows how much they can expect to get back from an investment as it takes into account the riskiness of the project and doesn’t ignore the time value of money. However, the NPV approach those have some disadvantages as well. The main disadvantage to the net present value approach is that it is sensitive to discount rates. The computations of NPV are a summary of multiple discounted cash flows that are converted into present value terms for the same point in time. This could affect the result both positively and negatively, and as said earlier, it is almost impossible to predict what the future brings. Let’s use the example given in the article “Uses, abuses and alternatives to NPV” by Ross (1995). If the current interest rate leads to a negative NPV, but in the future the interest rate decreases and leads to a positive NPV. The management or analyzers may miss out on a good investment opportunity if they sell the project early because with the current interest rate it is considered not profitable. Another example, let’s call it project a, could be if we were

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