Question

Please explain when do we have a conflict for the results produced by IRR and NPV methods in evaluating a project and discuss the reasons for the conflict as well as a solution to eliminate the conflict.

Answer 1

NPV and IRR, are two important measure of capital budgeting evaluation. NPV method provides result in term of Dollar as excess to value of investment and IRR method provides result in term of percentage as percentage return on initial investment.

Sometime NPV and IRR method provide conflicting result in term of acceptance of project. The reason behind this conflict is the assumed reinvestment rate. the NPV calculation implicitly assumes that intermediate cash flow is invested at cost of capital rate and IRR calculation assumes that the rate at which cash flow are reinvested is the IRR rate.

To eliminate this conflicting result the company either should use Net present value method to accept the project or use MIRR method.