Please help this topic...I guess it's very basic..but I am very confused...for investment decisions of IRR and NPV, positive NPV project (IRR>hurdle rate) should be accepted. When it's negative NPV, it should be rejected. Here, when NPV=0, it should be accepted under NPV method. How about IRR method? When NPV=0, I think it's IRR=hurdle rate. Becker (B3-16 & 20) says to be rejected. Wiley in one of MC answers says to be accepted (Module 44-51)...please help..Thank you!
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bobkorz
offlineMemberThink of it this way.
When NPV = 0 or IRR=hurdle rate, what's the point of taking the project if you're just earning what you ALREADY are earning? You're already earning the hurdle rate on other projects, why take on another project where you're just breaking even (on a cost of capital basis)?
√ FAR - 81 10/2011 √ AUD - 84 11/2011 √ BEC - 89 01/2012 √ REG - 82 02/2012
√ ethics - 90 10/2011 √ CPA Certificate √ CPA License certificate
REGISTERED LICENSED ILLINOIS CPA
PMP - Pass - 3P 2MPPosted 5 months ago # -
Justinnnn
offlineMemberCPA punk, I will agree that this was a confusing area - I read this chapter back to back twice before moving on. I think I understand this concept pretty well, someone correct me if I am wrong.
The IRR equates the present value of inflows with the initial investment. Thus when you use the IRR method, the NPV is already 0 (BEC 3-16 indicates you can accept projects with a NPV >= 0, including "equal to"). Using the IRR method, if the IRR is greater than the hurdle rate (BEC-20), you would accept the project even though the NPV is 0 because it is implicit in this budgeting technique.
Bobkorz's response is incorrect because using the IRR method itself implies it is acceptable to take projects with a 0 NPV, as long as the IRR calculated exceeds the hurdle rate.
Short Version:
Accept projects with a NPV greater or equal to 0 (however see the profitability index discussion on BEC -22 - NPV of 0 would be the lowest rank with an index of 1)
Accept IRR projects, which has a NPV of 0, with an IRR greater than (not equal to) the hurdle rate.REG 80 2/7/11
FAR 91 10/8/11
AUD 97 11/22/11
BEC 96 2/4/12Posted 4 months ago # -
Yvonne570
offlineMemberIt's more of a judgement call. This is an area where estimation is heavy and these tools assist with decision making. Think of it like this, if the present value of cash inflows equal the initial investment over time, would you accept it? If it was negative - overall cash inflows are less than the investment, i'm sure you would not accept that. These are all estimates; however, it's best not to accept something if it's going to lead to negative results overall. As for the differences, please give us more specific information - MCQ question of Becker and the one for Wiley. Perhaps there's another trick in there or it's worded differently.
AUD - Passed:)
FAR - Passed:)
REG - Retake TBD
BEC - Missed by 3 points Retake TBDPosted 4 months ago # -
Justinnnn
offlineMember@Yvonne570
It's not a judgment call on the CPA exam. The AICPA has a specific answer in mind for questions like this (see post above). The "judgment" aspects include adjusting the discount rate for higher levels of risk, inflation, etc. But at the end of the day, when the NPV = 0, the investment will be accepted assuming unlimited capital under the NPV method.
If the exam question refers to limited capital and profitability indexes (Net PV of Inflows/Initial Investment), it might be a different issue because all indexes 1 or over are ranked, and NPV = 0 would have the lowest rank (index of 1). But Profitability Index is an extension of NPV, not NPV itself.
REG 80 2/7/11
FAR 91 10/8/11
AUD 97 11/22/11
BEC 96 2/4/12Posted 4 months ago # -
CPA-Convertible
offlineMember@cpa-punk. you mentioned "How about IRR method? When NPV=0, I think it's IRR=hurdle rate...", this is not necessary true under IRR, the rate you used to get NPV=0 is not the hurtle rate. Here is my take for NPV and IRR:
NPV:
Investment - fixed/known
Hurtle Rate - fixed/known (predetermined by management)
future cash flow - fixed/known
NPV- to be calculated based on all three numbers above to arrive a decisionIRR:
Investment - fixed/known
future cash flow - fixed/known
IRR - to be calculated based on two numbers above
The calculated IRR will be used to compare to hurtle rate for decision.The hurtle rate has already taken the cost of captial and other factors such as economic cost, profit return requirement, and compound into consideration. Therefore, even NPV = 0, that still means the project is profitable/meets the investment requirement.
AUD - Passed - 8-31-11
BEC - Passed - 11-29-11
FAR - Passed - 2-29-12
& REG - Scheduled - 5/31/12Posted 4 months ago #
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