Project appraisal techniques are used to evaluate possible investment opportunities and to determine which of these opportunities will generate the best return to the firm’s shareholders. Therefore, it is vital for the firm if they wish to continue receiving funds from shareholders to employ the best techniques available when analysing which investment opportunities will give the best return. There are two types of project appraisal techniques: non-discounted cash flows and discounted cash flows. The Net Present Value and internal rate of return, examples of discounted cash flows, are in use in many large corporations and regarded as more effective than the traditional techniques of payback and accounting rate of return. In this paper, I
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The first assumption is the existence of a perfect capital market so a market where managers will never find themselves unable to take on a positive NPV project because of the lack of finance. The second assumption is that the discount rate correctly reflects the degree of risk involved in the project. The discount rate should represent the return available elsewhere in the capital market on a similar risk investment. And finally in the case of mutually exclusive projects with unequal lives, a third assumption that must be made is that mutually exclusive projects are isolated investments. This means that they do not form part of a replacement chain so it is assumed that the nature of the mutually exclusive project chosen will not be replaced when it reaches the end of its life. Without this assumption, then it requires a more complex decision rule (Brealey and Myers 126-29). Although the NPV method has been able to include modifications for these special cases, not all of the other appraisal techniques have been as successful.
The internal rate of return is the average annual return earned through the life of an investment and it computes a break-even rate of return which shows the discount rate below which an investment results in a positive NPV and above which an investment results in a negative NPV. My analysis of evaluative techniques will not focus on the non-discounted cash flow