The finance department of a large corporation has evaluated a possible capital p

Question

The finance department of a large corporation has evaluated a possible capital project using the NPV method, the Payback Method, and the IRR method. The analysts are puzzled, since the NPV indicated rejection, but the IRR and Payback methods both indicated acceptance. Explain why this conflicting situation might occur and what conclusions the analyst should accept, indicating the shortcomings and the advantages of each method. Assuming the data is correct, which method will most likely provide the most accurate decisions and why?

Explanation / Answer

The net present value (NPV) is the present value of the future after-tax cash flows minus the investment outlay. The investment rule is to invest if the NPV is greater than zero which means positive and not to invest if the NPV is less than zero which means negative. The IRR is the rate of return that makes the present value of the future after -tax cash flows equal to investment outlay. An investment should be accepted if its IRR is higher than its cost of capital and rejected if it

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