Question

Some financial mangers prefer capital budgeting models such as internal rate of return (IRR) or non- discounted payback models over the net present value (NPV) the model, which is preferred by academic financial analysts. Why? Briefly discuss. [Word Limit: 500 words]

Answer 1

Given that 8- Some financial mangers prefar Copital budgeting models such as internal rate of retorn CIRR) or non-discounted Payback models over the net present value Cupu) gol!. Financial managers polar IRR as a Capital budgeting model because it quickly tells them how much rate of rolum is to be expected for the risk involved in the investment decision. The financial manager can than compare the expected rate of returns to their desired rate of return and then decode to make the investment or not. if the expected rate of return is more than the reguired rote of roturn than the investment proposal is feasible and the investment should not be pursued when the expected rate is lan than the required rate of return. Non - discounted payback models is a simple technique that financial managers use to know the number of years it takes for a project to payoff its initial investment. The simplicity of this method makes it a useful tool for financial manger to make Capital budgeting decisions. Academic financial analysts prefer the not present value model because this model will discount the future cash flows that a project will receive to its present value and then compare it with the initial investment. If the discounted Cash flows of the project is greater than its initial investment, then the project is feasible and the investment should not be made When the des Counted cash home in lon than the initial investment.

The IRR technique is useful in knowing the expected rate of return, the NPV model is useful in deciding Whether to make an investment decision at the minimum acceptable rate of return.