Home Depot Inc. is considering making an investment to bolster its portfolio. Because, the company prides itself in making “disciplined capital allocation,” (Home Depot, 2015) it is imperative that it makes the best investment decision using approaches such as the net present value (NPV) and the internal rate of return (IRR) calculations. According to provided data, Home Depot made an initial investment outlay of $65 million. Additionally, the investment decision would depend on the company’s cash flows. For instance, the NPV “assumes cash flows are reinvested at the cost of capital,” while the IRR “assumes cash flows are reinvested at the internal rate of return” (Peterson & Fabozzi, 2002, p. 89).
Implications of the NPV and IRR Calculations …show more content…
On the other hand, if the IRR meets a set threshold at which point the investment’s cash flows exceed its costs, the company could assume the investment as worthwhile (Peterson & Fabozzi, 2002).
In the case of Home Depot’s financial data, the company had cash flows of -$5.53 million, -$8.78 million, $4.55 million, -$2.28 million, and $21.78 million in respective financial periods. Thus, the NPV calculations result in $101.6 million. Ideally, it means that the given investment would be a good call according to the NPV calculations. However, using the same data, the IRR calculations result in a -15% value, which indicates that the investment would be unacceptable.
Because of the calculations’ high NPV, Home Depot expects the investment to create value for its shareholders despite the prevailing risks, such as, strong market competition and an ability to respond to consumer trends (Home Depot, 2015). On the other hand, the use of the IRR approach on Home Depot’s data presents a challenge because the cash flow data contains several reported negative and positive cash flows. Thus, the high NPV value is a good fit for deciding whether Home Depot should continue looking into the
Implications of the NPV and IRR Calculations …show more content…
On the other hand, if the IRR meets a set threshold at which point the investment’s cash flows exceed its costs, the company could assume the investment as worthwhile (Peterson & Fabozzi, 2002).
In the case of Home Depot’s financial data, the company had cash flows of -$5.53 million, -$8.78 million, $4.55 million, -$2.28 million, and $21.78 million in respective financial periods. Thus, the NPV calculations result in $101.6 million. Ideally, it means that the given investment would be a good call according to the NPV calculations. However, using the same data, the IRR calculations result in a -15% value, which indicates that the investment would be unacceptable.
Because of the calculations’ high NPV, Home Depot expects the investment to create value for its shareholders despite the prevailing risks, such as, strong market competition and an ability to respond to consumer trends (Home Depot, 2015). On the other hand, the use of the IRR approach on Home Depot’s data presents a challenge because the cash flow data contains several reported negative and positive cash flows. Thus, the high NPV value is a good fit for deciding whether Home Depot should continue looking into the