Evaluating the Accuracy of Net Present Value and Initial Rate of Return Investment Rules

Abstract

The purpose of this paper is to compare the accuracy of two investment decision-making methods, Net present value (NPV) and Internal rate of return (IRR), using four different hypothetical investigations, and to briefly assess the limitations of the NPV method. The use of the IRR rule results in incorrect judgments in four situations: delayed investment, multiple IRRs, no IRRs, and mutually exclusive projects (different scales). However, the judgment method shows the sensitivity of the investment decision to the uncertainty of the cost of capital estimation in the case of delayed investment and two IRRs.