Page 29 - PowerPoint Presentation

CAPITAL INVESTMENT APPRAISAL

Internal Rate of Return (IRR)

• When dealing with an independent investment that has cash outflows followed by
cash inflows, it should be accepted if the IRR exceeds the cost of capital (discount
rate).

• This is because such investments will have positive NPVs. Where the IRR = the
WACC the company breaks even and if the IRR is less than the WACC the project
should be rejected.

• However, where investments are mutually exclusive:

NPV of Project A: + 22 940 (calculated previously)

NPV of Project B: + 28 660 NPV is superior!!

• Therefore using NPV’s it appears that Project B is superior but using IRR it appears
that Project A is superior. This is because the incorrect reinvestment assumption is
made when calculating IRR.

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