Provide thoughts in 100 words on the below and provide an example.
What are the differences in the calculation of net present value and internal rate of return?
When two or more projects are evaluated, sometimes management must only choose one (and hope it is the project to bring in the highest return). NPV is what a project is worth and costs. Management is required to find NPV opportunities which are positive and try to avoid negative outcomes of NPV. While hoping the project obtains a high rate of return.
If you have the opportunity to build a house on possible four plots of land, you have to decided which plot of land is best for you and your family. This is possibly an easy selection for most of you. Now, if one has to make a choice from three different house plans and four possible plots of land; the decision making process may require additional time and research. One may run into conflicting differences (e.g. One type of house may not work within a specific area). Though there are two mutually exclusive projects, one has a wide range of factors to research before making a final decision. Why? One can only choose one style of house and one plot of land and hope it is the best outcome now and in the future.
Management goes through a similar process, but management is challenged because sometimes IRR may not agree with the NPV. This could be due to the size of a project and the cash flow timing (the value of a dollar today as opposed tomorrow). Does management want to have more wealth or higher IRR, or wealth or higher profitability index? These are minor questions, but this gives you an idea of how mutually exclusive projects cause conflicting differences.