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Net Present Value (NPV) is an indicator of how much value an investment or project adds to the firm to help firm in making investment decision. NPV rule is the most accurate and reliable rule, in practice a wide variety of rules are applied. However, Graham and Harvey's study indicates that one-fourth of U.S. corporations do not using the NPV rule. Exactly why other capital budgeting techniques are used in practice is not always clear. Similar to NPV, the intemal rate of return (IRR) investment rule, one of capital budgeting tools is based on the concept that the return on the investment opportunity you are considering is greater than the return on other alternatives in the market with equivalent risk and maturity. In general, the IRR rule works for a stand-alone project if all of the project's negative cash flows precede its positive cash flows. In most cases, investment with high NPV will tend to have higher IRR. However, in other cases, the IRR rule may disagree with the NPV rule and thus be incorrect. The conflict happened when mutually exclusive project has higher NPV but has lower IRR than the other project. This conflict can be solved by preparing NPV profile. Figure 1 and Figure 2 illustrate two different NPV Profile.

Required: (a) A survey found that a sizeable minority of firms(25%) in their study do not use the NPV rule at all. In addition, About 50% of firms surveyed used the payback rule. Furthermore, it appears that most firms use both the NPV rule and the IRR rule. Explain this phenomenon on why do firms use rules other than NPV if they can lead to erroneous decisions?(5marks)

Figure 1: NPV Profile 1 - 12.20 100.000 77.880 $9.762 rance $120,000 $100.000 $80,000 $60,000 - 10,547 -2732 NPV 29 $40,000 -3823 10:30 $20.000 IRR = 5.79% 13.065 20.030 $0 5% 1090 1596 2046 2596 3096 36.402 53.10 *7018 70,014 79.101 -$20,000 Cost of IRR = 13.809 Capital Discount Rate Figure 2: NPV Profile 2 IRR for A= 19.43% $160.00 $140.00 $120.00 IRR for B = 22.17% Crossover Point 11.8% NPV $100.00 $80.00 $60.00 $40.00 $20.00 $0.00 ($20.00) ($40.00) 0.05 0.1 0.15 0.2 0.25 0.3 Discount Rate Figure 1: NPV Profile 1 - 12.20 100.000 77.880 $9.762 rance $120,000 $100.000 $80,000 $60,000 - 10,547 -2732 NPV 29 $40,000 -3823 10:30 $20.000 IRR = 5.79% 13.065 20.030 $0 5% 1090 1596 2046 2596 3096 36.402 53.10 *7018 70,014 79.101 -$20,000 Cost of IRR = 13.809 Capital Discount Rate Figure 2: NPV Profile 2 IRR for A= 19.43% $160.00 $140.00 $120.00 IRR for B = 22.17% Crossover Point 11.8% NPV $100.00 $80.00 $60.00 $40.00 $20.00 $0.00 ($20.00) ($40.00) 0.05 0.1 0.15 0.2 0.25 0.3 Discount Rate

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