business finance
write comments on #1 & #2 about 3 lines each separately
#1
I would rely more on NPV, while not neglecting IRR at the same time. Let me illustrate with an example: suppose a big company A wants to buy a small company B. Company A determines the future cash flows generated by the company B, when discounted at a 12% annual rate, yield a present value of $23.5 million. If the company B’s owner is willing to sell for $20 million, then the NPV of the project would be $3.5 million. The $3.5 million dollar NPV represents the intrinsic value that will be added to company A if it buys company B. So this project has a positive NPV, but from a business perspective, company A should also know what rate of return will be generated by this investment. To do this, company A set the NPV factor to zero and solve for the now-unknown discount rate. the rate that is produced by the solution is the project’s internal rate of return. For this example, the project’s IRR could, depending on the timing and proportion of cash flow distributions, be equal to 17.15%. Thus, company A, given its projected cash flows, has a project with a 17.15% return. If there were a project that company could undertake with a higher IRR, it would probably pursue the higher-yielding project instead. Thus, the usefulness of the IRR measurement lies in its ability to represent any investment opportunity’s return and to compare it with other possible investments.
#2
To begin with, I would like to provide the definitions of both net present value (NPV) and internal rate of return (IRR) in order to then explain my choice.
“Net Present Value (NPV) is the difference between the present value of cash inflows and the present value of cash outflows.” (Net Present Value) On the other hand, “internal rate of return (IRR) is the interest rate at which the net present value of all the cash flows (both positive and negative) from a project or investment equal zero.” (Internal Rate of Return)
Now, what is the main difference between these two notions and which one is more reliable when taking important investment decisions? “The IRR answers the question “what rate of return will I achieve, given the following stream of cash flows?”, while the NPV answers the question “what is the following stream of cash flows worth at a particular discount rate, in today’s dollars?” (Schmidt, 2013)
Finally, to answer a given question, I think both IRR and NPV are reliable and they just fit different situations. Depending on what project we are dealing with, either IRR or NPV will be more or less appropriate.
Answer preview
Response One
When purchasing a company a lot of things have to go to considerations; a company has to know what they are getting from the purchase. NPV will be important when purchasing a company since it shows the company’s income net of existing costs. When the NPV is positive, it shows that the income is more than the costs and hence a good deal…
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