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On the basis of this net present value
calculation this is clearly a very good investment opportunity since it
will increase the wealth of the shareholders by around £5,670 based on
current estimates. In fact any project that offers a positive NPV will
increase shareholders' wealth and should be undertaken. However, in practice
the number of potential projects available may be limited, and managerial
time and investment funds may also restrict the range of projects formally
evaluated. Where such restrictions limit the number of projects that can
be undertaken, then those with the greatest NPVs are clearly preferable.
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The Internal Rate of Return (IRR)
A calculation of the internal rate of return provides
an alternative discounting technique. The internal rate of return for
a project is the discount rate that, if applied, would result in a Net
Present Value of zero. This can be calculated accurately by computer
or estimated by interpolation: By trial and error using different discount
rates it is possible to find one discount rate that gives a small positive
NPV and one that gives a small negative NPV. Clearly the IRR will lie
somewhere between these discount rates:
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