Page 22 - FINAL CFA SLIDES DECEMBER 2018 DAY 11
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Session Unit 10:
35. Capital Budgeting
The Relative Advantages and Disadvantages of the NPV and IRR Methods, p.30
• A key advantage of NPV is that it is a direct measure of the expected increase in the value of
the firm. NPV is theoretically the best method.
• Its main weakness is that it does not include any consideration of the size of the project.
For example, an NPV of $100 is great for a project costing $100 but not so great for a
project costing $1 million.
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• A key advantage of IRR is that it measures profitability as a %, showing the return on each
dollar invested.
• The IRR provides information on the margin of safety that the NPV does not – helps us
determine how much below the IRR the actual project return could fall, in % terms, before the
project becomes uneconomic (has a negative NPV).
• The disadvantages of the IRR method are (1) the possibility of producing rankings of mutually
exclusive projects different from those from NPV analysis and (2) the possibility that a project
has multiple IRRs or no IRR.
