Companies rate of return on the initial project.
Companies will use investment appraisals in order to
evaluate the attractiveness of an investment. When considering whether an
investment will achieve a targeting yield, net present value will show the
estimate of the present value of cash flows. From the figures shown in the
table, we gather that the NPV for the project is £160,415; this positive NPV
indicates that the estimated earnings generated by the investment will surpass
the cost of the project. Therefore the project will be profitable and can be recommended
on financial grounds.
When assessing the viability and attractiveness of a
project, businesses will also use the internal rate of return. This method is
used to calculate the rate of return on the initial project. In order to
calculate IRR the NPV of all cash flows from the project would have to equal to
zero, IRR will be presented as a percentage return the company is expected to
make from the project. The internal rate of return for the project is 17.37%,
which is greater than the discount rate used, this shows that the project is
desirable as the IRR exceeds the companies required rate of return. IRR allows
projects to be ranked based on overall rate of return, with investments with
the highest IRR favoured.
Both the Internal rate of return and the Net present value
are vital when assessing the outcome of a new project. NPV takes into account the idea that a
currency will be worth more in the future, therefore allowing investors to know
whether an investment will create value. The IRR method presents an easy to
measure percentage, which is simple to interpret and understand. Internal rate
of Return also has disadvantages such as at time having conflicting answers
when compared to NPV. However, both methods are heavily dependent on
estimations and assumptions, which will mean there is substantial room for
error as the project might not have return as estimated.