Finance Different Investment Assessment Tools Essay

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However, there are also some disadvantages with this assessment tool. The assessment is based on projections, if there are any divergences from those projections there can be a significantly different outcome. The net present value also has an inherent bias towards projects which provide higher short-term returns, due to the compounding effect of the discount applied to returns in later years. The use of NPV may also be difficult as the result is a dollar value, which can create ambiguity when comparing very different types of projects, especially where there is a significantly different investment amount.

Internal Rate of Return

The internal rate of return (IRR) is a calculation which assesses the rate of return created by a particular investment as a percentage of the amount invested. The calculation itself is based on a net present value calculation, and a net present value calculation it is negative in order to assess the internal rate of return.

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However, this investment assessment tool is often easier to understand by investors, as it provides a rate of return as a percentage, which makes it easier to compare different types of investment in a proportional manner. If a rate of return is provided, it is also possible to assess the investment against benchmarks, such as the cost of borrowing money for the project, rejected the project or investment if the rate of return is not high enough.

There are a number of disadvantages associated with the internal rate of return. The absence of a dollar amount means that two different.....

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