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Under what circumstances is NPV considered technically superior to IRR in investment decision-making?
NPV is preferred when there are non-conventional cash flows (alternating positive and negative cash flows) as IRR may produce multiple solutions, making it difficult to interpret.
NPV accounts for the time value of money by discounting future cash flows at the appropriate cost of capital, while IRR assumes reinvestment of intermediate cash flows at the IRR itself, which can be unrealistic.
For mutually exclusive projects, NPV is generally favored as it provides a more reliable estimate of future profitability, especially when project scales differ.
NPV reflects the true incremental value created per unit of investment, while IRR may mislead by favoring smaller projects with higher percentage returns but lower overall value creation.
When the cost of capital varies over time or in specific risk scenarios, NPV calculations can adapt more effectively, providing useful insights compared to a single IRR value.
NPV allows for direct comparison of absolute dollar values, making it easier for decision-makers to understand the magnitude of value addition, unlike the relative percentage return provided by IRR.
NPV is preferred when evaluating public sector or social investment projects where the objective is to maximize societal benefit rather than just financial returns.
NPV is more appropriate when dealing with capital rationing, as it can help identify the project(s) that contribute the highest value per unit of limited capital.
NPV is superior when comparing projects with different economic lives, as IRR may favor shorter-lived projects that generate higher periodic returns.
NPV is better suited for evaluating investments in research and development or other projects with intangible benefits that are difficult to quantify using IRR.
NPV provides a clearer indication of a project's true profitability and cash flow generation potential, which is particularly important for capital-intensive investments.
NPV can handle varying discount rates, allowing for more accurate analysis of projects with different risk profiles, while IRR assumes a constant discount rate.
NPV can be easily adjusted to incorporate sensitivity analyses and scenario planning, making it a more flexible tool for decision-making.
NPV is preferred when the objective is to maximize the wealth of shareholders, as it directly measures the value addition to the firm.
NPV is considered more theoretically sound and aligned with the goal of wealth maximization, as it is consistent with the principle of time value of money.
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