Net Present Value ( Npv ) And Internal Rate Of Return Essay

Net Present Value ( Npv ) And Internal Rate Of Return Essay

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

This tool looks at a series of cash inflows and outflows of Digitalis in the future and assigns the project a present value. It is important to take into consideration Digitalis’ Weighted Average Cost of Capital (WACC). This is the average return rate that the Digitalis would expect to cover all its investors, for Digitalis this is 15%. China has the highest NPV value of £385 million, higher the NPV, the more attractive project.

NPV fails to consider the presence of potential constraints in Digitalis’ structure that may restrict the amount of capital generated. This potential restrictions may hinder the clarity of the outcome of this project evaluation. Another limitation of NPV is its sensitivity to its discount rate. A slight change in the discount rate would have a considerable effect on the final output of the NPV calculations.

Although IRR is a separate evaluation tool, it is imperative it be read along with NPV. IRR is the discount rate at which, the present value of future cash flow equals Digitalis’ investment. This evaluation tool allows us to understand the investor 's yield on their initial investment. Digitalis should opt for a project that has an IRR value greater than its cost of capital of 15%. China has the highest IRR (30%) of all BRICS projects when compared to cost of capital. This project would generate enough return to compensate investors for using their capital. Since NPV is greater than 0 and IRR is greater than the discount rate, the investment into China seems promising.

The IRR evaluation could be misleading. A project may have a low IRR but a high NPV, meaning that the rate at which investors yield their initial investment may be low, but...


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...Project D being substantially higher than other projects. This NPV value amalgamated with a high IRR value augments our belief in the success of the project. However, investors would take 6.2 years to recover their initial investment but the overall value that would be added to Digitalis is much greater than the other projects. The other facet that increases the probability of success is the profitability Index which is 1.42.

Digitalis should appreciate the demographic advantage of Project D. This demographic advantage allows for Digitalis to have a larger demand population client base. An uncertainty that would affect the profits of Digitalis is the economic slowdown that China is facing. The decrease in GDP amalgamated with a slowdown in foreign investment and tax regulations would augment the uncertainty in the structural working of Digitalis in another country.

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