Purpose: The NPV method focuses on project surpluses, while IRR is focused on
the breakeven cash flow level of a project.
Decision support: The NPV method presents an outcome that forms the foundation
for an investment decision, since it presents a dollar return. The IRR method does
not help in making this decision, since its percentage return does not tell the
investor how much money will be made.
Reinvestment rate: The presumed rate of return for the reinvestment of
intermediate cash flows is the firm's cost of capital when NPV is used, while it is
the internal rate of return under the IRR method.
Discount rate issues: The NPV method requires the use of a discount rate, which

can be difficult to derive, since management might want to adjust it based on
perceived risk levels. The IRR method does not have this difficulty, since the rate
of return is simply derived from the underlying cash flows.
Generally,
NPV
is
the
more
heavily-used method. IRR tends to be calculated as part of the capital budgeting
process and supplied as additional information.
The NPV and IRR methods sometimes gives contradictory results when used for
selection of the most profitable investment project from among mutually exclusive
projects. The contradictory results are due to the different assumptions underlying
the two methods. The NPV method assumes that the cash inflows generated during
the operational life of the project are reinvested at the discount rate. Whereas in the
IRR method all future streams of cash inflows are reinvested at the yield rate over
the life of the project. Since the objective is to maximize wealth, the NPV provides
the correct criteria of investment decisions. A project with the maximum NPV
makes maximum contribution to the present value of the firm. Hence NPV is better
alternative than IRR.
4. A firm's after-tax cost of capital of the specific sources is as follows:
Cost of debt: 7 per cent
Cost of preference shares: 12 per cent
Cost of equity funds: 17 per cent
The following is the capital structure:
Source Amount Debt Rs. 250,000
Preference capital Rs. 150,000
Equity capital Rs. 600,000
Total: Rs. 10,00,000
Calculate the weighted average cost of capital. In case the firm plans to raise
additional capital
of Rs. 5 Lacs through 100,000 Debt and remaining through Equity

Section B (10 Marks)
Attempt the following questions
1. A company is planning to raise Rs. 50 Lacs. Given tax rate of 30%, please
advise on the most optimum alternative:
(i) Bank loan at 12% interest. Loan to be redeemed at the end of 10 years. Flotation
cost is 5 %
(ii) Raise Rs. 25 Lacs through issue of Preference shares for 10 years at 14%, with
3% flotation cost; and the remaining Rs. 25 Lacs through Bank Loan at 12%
interest rate. Loan to be redeemed at the end of 10 years. Flotation cost is 5%.

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- Net Present Value, HPCL