ACC501 - GDB # 3 - Solution Idea
Posted: Mon Jan 14, 2013 8:33 pm
1. Why IRR (Internal Rate of Return) is different for all three projects?
ANS: IRR involve time value of money.
2. Why AAR (Average Accounting Return) is same for all three projects?
ANS: it does not involve time value of money
3. Which of the techniques is better to use in order to select the project in this particular scenario and why? Explain with rationale.
ANS: IRR will be better it involve time value of money
Make answer as per ur understanding
• Drawbacks of AAR
– It is not a rate of return in any meaningful economic sense, as it ignores time value
of money
– It lacks an objective or target AAR to be compared with
– It focuses on net income and book value rather than cash flow and market value
• Advantages
– Easy to calculate
– Needed information will usually be available
With IRR, we try to find a single rate of return that summarizes the merits of a project
• We want this rate to be an “internal” rate in the sense that it only depends on the cash
flows of a particular investment, not on rates offered elsewhere
• Consider a project that costs $100 today and pays $110 in one year.
• Obviously it pays a return of 10%, since it pays $1.10 for every dollar we put in.
• This 10% is in fact the internal rate of return
ANS: IRR involve time value of money.
2. Why AAR (Average Accounting Return) is same for all three projects?
ANS: it does not involve time value of money
3. Which of the techniques is better to use in order to select the project in this particular scenario and why? Explain with rationale.
ANS: IRR will be better it involve time value of money
Make answer as per ur understanding
• Drawbacks of AAR
– It is not a rate of return in any meaningful economic sense, as it ignores time value
of money
– It lacks an objective or target AAR to be compared with
– It focuses on net income and book value rather than cash flow and market value
• Advantages
– Easy to calculate
– Needed information will usually be available
With IRR, we try to find a single rate of return that summarizes the merits of a project
• We want this rate to be an “internal” rate in the sense that it only depends on the cash
flows of a particular investment, not on rates offered elsewhere
• Consider a project that costs $100 today and pays $110 in one year.
• Obviously it pays a return of 10%, since it pays $1.10 for every dollar we put in.
• This 10% is in fact the internal rate of return