The crucial decision of investment decision is also termed as capital budgeting, is central to the success of the company. Riddhi Siddhi Multi Services have already seen that capital investments sometimes absorb substantial amounts of cash; they also have very long term consequences. The assets you are purchasing today may affect the business you are in for many years.

The net present value rule states that managers increase shareholders’ wealth by accepting all projects that are worth more than they cost. Therefore, they should accept all projects with a positive net present value.

Some people confuse the internal rate of return on a project with the opportunity cost of capital. Remember that the project IRR measures the profitability of the project. It’s the internal return rate in the sense that it depends only on the projection of own flows of cash.

The opportunity cost of capital is the standard for deciding whether to accept the project. It is equal to the return offered by equivalent-risk investments in the capital market.


These days almost all large companies use discounted cash flow in some form, but sometimes they use it in combination with other theoretically inappropriate measures of Let’s pause for a moment to review. We have seen that the NPV rule is the most reliable criterion for project evaluation. NPV is reliable because it measures the difference between the cost of a project and the value of the project. That difference—the net present value—is the amount by which the project would increase the value of the firm.

Other rules such as payback period or book return may be viewed at best as rough proxies for the attractiveness of a proposed project; because they are not based on value, they can easily lead to incorrect investment decisions. IRR is clearly the best choice as the alternatives to the NPV rule in that it usually results in the same accept-or-reject decision as the NPV rule, but like the alternatives, it does not quantify the contribution to firm value. We will see shortly this can cause problems when managers have to choose among competing projects.

Riddhi Siddhi Multi Services are now ready to extend our discussion of investment criteria to encompass some of the issues encountered when managers must choose among projects that interact-that is, when acceptance of one project affects another one. The NPV rule can be adapted to these new problems with only a bit of extra effort. But unless you are careful, the IRR rule may lead you astray.


Most of the projects Riddhi Siddhi Multi Services have considered so far involve take-it-or-leave-it decisions. But almost all real-world decisions about capital expenditures involve either–or choices.

You could build an apartment block on that vacant site rather than build an office block.
You could build a 5-story office block or a 50-story one. You could heat it with oil or with natural gas. You could build it today, or wait a year to start construction. Such choices are said to be mutually exclusive.

Remember, a high IRR is not an end in itself. You want projects that increase the value of the firm. Projects that earn a good rate of return for a long time often have higher NPVs than those that offer high percentage rates of return but die young.

Author's Bio: 

Great financial services at Riddhi Siddhi Multi Services in low interest rates.