Hi Sir
In one of my question bank solutions, it says the following:
'The IRR is basically the discount rate that produces an NPV of zero for net project
cash flows. If the selection is between two projects with the same scale of
investment (which is the case here), then it has no effect on which project is
selected.'
What do they mean by scale here sir? I thought they were referring to the monetary value/size of the investment alternatives, but then when I checked the question, I saw that the initial and total investment cash outflows were different, one required a £110k investment, whilst the other required a £90k investment.
Thank you,
Ali
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IRR
5y ago#1In your example, there is little difference between the scale of investment ie 90 v 110.
It is talking about comparing an investment of 10 with an IRR of 20% to an investment of 1,000,000 with an IRR of 10%. The first one is trivial whatever its IRR. The second is much more significant.
Thanks sir.
(1) Is there a 'rule of thumb' for (or just a sensible way of determining...) when differences in the size of the respective project's investment are significant enough to be considered to be investments of differing scales?
Best Regards,
Ali
5y ago#3Not really. The problem really only arises if the projects are mutually exclusive otherwise do both. NPV is more reliable in this case as it tells you in absolute terms how much richer doing a project will make you.
Thank you - I really appreciate it. Have a great day.
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