Investment Appraisal and Capital Budgeting - Essay Example

Net Present Value enables us to understand the possible profits a company would earn if a certain project is taken up. It provides results that are simple to comprehend. This is a very useful method for comparing projects of the same size mostly least cost situations. NPV enables the comparison of various rates of interest and also helps analyze what the earning would be if another project were taken up (Weston and Copeland, 1988). The main drawback of this method is that it does not take into account the profitability of a project. This is accomplished by computing the profitability index (PI) for the projects and taking the decision accordingly. Hence both NPV and PI must be computed to be able to arrive at a profitable and rational decision (Burke and Wilks).

Internal rate of return on the other hand can be used to assess risk in all projects and it has an intuitive appeal. This method bases its calculations on the cash flows rather than on earnings. However, it is not possible to have an accurate solution using this method since one project can have more than one IRR, with very extensive and complicated calculations (Lefly).