1.
Do you see any reason that the IRR should still be in use today since the NPV is more accurate?
Please write out one to two paragraphs explain why. Thank you
Solution
The Internal Rate of Return(IRR) is usually the rate of return that a project earns. IRR is the
discount rate that equates the aggregate present value of the net cash inflows with the aggregate
present value of cash outflows of a project. In other words, it is that rate which gives the project
NPV of zero.
The IRR method is a theoretically correct technique to evaluate capital expenditure decisions. It
has the advantages which are offerred by the NPV criterion such as a) it considers the time value
of money and b) it takes into account total cash inflows and outflows.
In addition, it is easier to understand. People understand the concept of IRR much more readily
than they understand the concept of NPV. For example , business people are more likely to
understand the concept of the IRR when it is linked to the concept of k, the cost of capital. Also,
a required rate of return is a prerequisite for computing the NPV. The discount rate used in NPV
calculations is a result of a number of assumptions which may or may not be realistic. On the
other hand, a discount rate is not a prerequisite for computing the IRR. It does not use the
concept of the required rate of return or cost of capital.It itself provides a rate of return which is
indicative of the profitability of the proposal.
Finally, the IRR is consistent with the overall objective of maximizing stockholder wealth.