Coyote and Bird run the Acme Fireworks Company and are trying to decide whether or not...
Coyote and Bird run the Acme Fireworks Company and are trying to decide whether or not to purchase new equipment to streamline the production process. Coyote argues that they should use IRR as the basis for making the decision while Bird argues they should be using the NPV. They ask you, as the chief financial officer of the company your thoughts on the capital budgeting decision. What do you tell them?
Homework Answers
Solution:
NPV is a better method for evaluating mutually exclusive projects than the IRR method. The NPV method employs more realistic reinvestment rate assumptions, is a better indicator of profitability and shareholder wealth, and mathematically will return the correct accept-or-reject decision regardless of whether the project experiences non-normal cash flows or if differences in project size or timing of cash flows exist.
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