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Weaknesses of the IRR Method:
The Internal Rate of Return (IRR) is considered as the discount rate that makes a cash flow's net value equal zero and it's the most useful means of project evaluations. Actually, the IRR method is one of the most widely used methods of measuring project worth as well as economic and financial analysis by many institutions like the World Bank. This is because this method represents the average earning power of monies used in a project over the entire life of the project making it to be referred to as yield of the investment in certain situations. In most cases, the computation of the internal rate of return method for project evaluation incorporates a trial and error method. The main rule when evaluating a project using this method is to acknowledge all investments in cases where the internal rate of return is higher than the opportunity cost of capital. Moreover, the internal rate of return is an...
The other advantage of this method is that the measure in the financial community also acknowledges the time value of money. Consequently, this measure offers excellent guidance of the value of a project when used properly. However, the use of the internal rate of return in project evaluation also has several weaknesses including:
Multiple Rates of Return:
This is one of the major weaknesses or pitfalls of using the internal rate of return method in the evaluation of projects since it's likely to have multiple or no IRRs. The possibility of the project to have multiple IRRs or no IRR occurs when the project being…
Capital Budgeting is a vital part of any business. Investment decisions, which need time to mature, must be based on the returns that they will make. If investment in a project is unprofitable in the long run, it would be unwise to invest in it. However, if the investment will be profitable, it is important to determine this early in the game. Because huge sums of money can be lost if
The IRR too does not distinguish between the positive investing or negative borrowing+ investing situation, whilst the NPV makes a clear distinction. NPV is superior to IRR for mutually exclusive investments. Finally, NPV and IRR make different assumptions when it comes to reinvestment assumptions. This can result in conflicts and crossover in ranking of mutually exclusive projects. Profitability Index (PI) The PI calculates the present value of a project compared to its
"MIRR: A better measure." Business Horizons. 51(4), 321-329. Cited in: http://econpapers.repec.org/article/eeebushor/v_3a51_3ay_3a2008_3ai_3a4_3ap_3a321-329.htm McClure, B. (n.d.). "Taking Stock of Discounted Cash Flow." Investopedia. Cited in: http://www.investopedia.com/articles/03/011403.asp?partner=answers "Modified Internal Rate of Return." (2009). Cited in: http://www.thinkanddone.com/finance/mirr.html Parrino, R, & D. Kidwell. (2009). Fundamentals of Corporate Finance. (Vol. 1, Ed.). Wiley Custom Solutions. Smart, S. And WL. Megginson. (2008). Corporate Finance. Thompson Learning. Sullivan, A. And S. Sheffrin. (2003). Economics: Principles in Action. Prentice-Hall. The IRR is the rate of return that makes the
Approximately 19% of the short-term liabilities in the form of notes payable and other short-term debt. The long-term liabilities consist of long-term debt and other miscellaneous liabilities. The debt portion of this represents approximately 39% of the total long-term liabilities. Johnson & Johnson has issued notes onto the market that mature in 2017, comprising the bulk of the long-term debt. The calculate the market value capital structure of JNJ, we need
SAC Capital Structure The Sparklin Automotive Company needs to make a capital investment of $3,000,000 to improve its manufacturing facilities. This investment needs to be carefully considered along two dimensions. The first of these is that the company needs to consider the investment from a capital budgeting point-of-view. The second is that the company does not want to change its capital structure as the result of this decision. The current capital
Financial Analysis of Bestwish Limited Company Overview Bestwish Limited produces extensive range of quality products such as gift dressing, greetings cards, and plush merchandise of more than 50,000 stocks. The production of different categories of products involve between 2 and 15 processes. The company produces standardized products and custom designed products ordered from customers on contract basis. However, Bestwish Limited is facing challenges to control the costs because of varying production process,