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Npv Irr And Pi

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Net Present Value (NPV), Internal Rate of Return (IRR) and Profitability Index (PI)

Comparisons of Net Present Value (NPV), Internal Rate of Return (IRR) and Profitability

Index (PI)

Net Present Value (NPV) and the Internal Rate of Return (IRR) are both valuable tools that

decision makers use to decide on the financial attractiveness of a given investment opportunity.

These tools provide comparative alternatives for decision makers for various investment choices

that may be available. The NPV uses an approach that lowers the future expected cash inflows

from a particular investment in a way that reflects the expected inflation, the desire of the

investors to keep some funds in case another opportunity may come up, and the investment risk

involved (Kierulff). A Net Present Value (NPV) can be used in capital budgeting when assessing

the profitability of a given project or investment, and it is the variance between inflows of cash

and the outflow at a given time (IMF). A Profitability Index (PI) can be obtained by dividing the

current value of a said project's future cash flow by the initial investment. If the figure got is

more than 1.0 then it is deemed as profitably being positive, while a figure of less than 1.0 shows

that the project is not a worthy investment as it will lead to losses.

Advantages and disadvantages of NPV, IRR, and PI and guidance on pecking order and

use

The advantage of using an NPV is that it gives a direct measure of the contribution by the

shareholders (Paterson-Drake). However, the drawback is it does not consider or measure the

size of the project. The IRR, on the other hand, has the advantage of displaying the initial

investments that were made. Nevertheless, it may lead to conflicting feedback when putting

against NPV especially for those projects that may be mutually exclusive (Paterson-Drake). The

IRR challenge is made even more challenging when the flow of cash during the project’s

lifecycle is negative and therefore operating at a loss. The advantage is that it can be a valuable

tool when deciding whether an investment is worthwhile or not. The drawback with a PI is that it

does not factor in the amount of investment and attaches no amount to the actual cash flows

(Paterson-Drake).

Guidance on the use of the different techniques

In their application, the tools would be invaluable to a manager when making the decision of the

ideal investment choice. The PI will provide the amount of return that a given project is bound to

bring, The NPV will provide the value of the project in terms of dollar value. Finally, the IRR

will guide the decision makers with the information on a specific project by providing the break-

even point.

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Surname 1 Name Instructor Institution Date Net Present Value (NPV), Internal Rate of Return (IRR) and Profitability Index (PI) Comparisons of Net Present Value (NPV), Internal Rate of Return (IRR) and Profitability Index (PI) Net Present Value (NPV) and the Internal Rate of Return (IRR) are both valuable tools that decision makers use to decide on the financial attractiveness of a given investment opportunity. These tools provide comparative alternatives for decision makers for various investment choices that may be available. The NPV uses an approach that lowers the future expected cash inf ...
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