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# 21 - that makes the present value of all expected future...

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Describe how the IRR and NPV approaches are related. The internal rate of return and the net present value methods are the two major approaches to evaluating capital budgeting projects. The NPV technique measures the present value of the future cash flows that a project will produce. A positive NPV means that the investment should increase the value of the firm and lead to maximizing shareholder wealth. A positive NPV project provides a return that is more than enough to compensate for the required return on the investment. Thus, using NPV as a guideline for capital investment decisions is consistent with the goal of creating wealth. The IRR measures a project’s yield or expected rate of return. This return does not depend on anything except the cash flows of the project. Thus, the IRR provides a single number summarizing the merits of a project. Mathematically, the IRR is that rate of return (discount rate)
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Unformatted text preview: that makes the present value of all expected future cash flows equal to zero. That is, the IRR is the discount rate that causes a project’s NPV to equal zero. The net present value (NPV) and the internal rate of return (IRR) could as well be defined as two faces of the same coin as both reflect on the anticipated performance of a firm or business over a particular period of time. The main difference however should be more evident in the method or the units used. While NPV is calculated in cash, the IRR is a percentage value expected in return from a capital project (Bruce, 2003). IRR and NPV are related in that both use the time value of money and take risk into account. NPV accounts for risk by using a risk-adjusted discount rate, while IRR uses a risk-adjusted hurdle rate against which to compare the project and make the accept/reject decision....
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