Question: Question 1 (Total 15 marks) Net Present Value (NPV) is an indicator of how much value an investment or project adds to the firm to
Question 1 (Total 15 marks)
Net Present Value (NPV) is an indicator of how much value an investment or project adds to the firm
to help firm in making investment decision. NPV rule is the most accurate and reliable rule, in practice
a wide variety of rules are applied. However, Graham and Harvey's study indicates that one-fourth
of U.S. corporations do not using the NPV rule. Exactly why other capital budgeting techniques are
used in practice is not always clear. Similar to NPV, the internal rate of return (IRR) investment rule,
one of capital budgeting tools is based on the concept that the return on the investment opportunity
you are considering is greater than the return on other alternatives in the market with equivalent risk
and maturity. In general, the IRR rule works for a stand-alone project if all of the project's negative
cash flows precede its positive cash flows. In most cases, investment with high NPV will tend to have
higher IRR. However, in other cases, the IRR rule may disagree with the NPV rule and thus be
incorrect. The conflict happened when mutually exclusive project has higher NPV but has lower IRR
than the other project. This conflict can be solved by preparing NPV profile. Figure 1 and Figure 2
illustrate two different NPV Profile.
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