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http://dx.doi.org/10.11627/jksie.2022.45.4.167

Do NPV and IRR Measure the Profitability of Investment Opportunities? Conditions as Measures of Profitability  

Jinwook Kim (Department of Industrial & Systems Engineering, Changwon National University)
Publication Information
Journal of Korean Society of Industrial and Systems Engineering / v.45, no.4, 2022 , pp. 167-173 More about this Journal
Abstract
Investors must adopt profitable investment opportunities to maximize their wealth. Almost all investment, finance, engineering economics textbooks explain that net present value (NPV) measures the profitability (or value) of investment opportunities in absolute size, and internal rate of return (IRR) measures the profitability of investment opportunities in relative proportions. However, NPV is a measure of the relative size of the return on investment opportunity to do-nothing alternative. Moreover, IRR can occur in multiple investment opportunities and may not exist. To make matters worse, IRR and NPV also have conflicting problems in accept-or-reject decisions. In this study, the reason why NPV and IRR cannot accurately measure the profitability of investment opportunities is identified, and fundamental characteristics that investment opportunity profitability measures should have are presented.
Keywords
Net Present Value; Minimum Attractive Rate of Return; Terminal Value; Internal Rate of Return; External Rate of Return;
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