Chapter 4 • Investment appraisal methods
It would be wrong to imagine that projects with unconventional cash flow profiles
do not occur in practice. Probably they form a minority of the total of all projects, but
they do exist nonetheless. For example, many projects involving mineral extraction
would show something like the cash flow characteristics of Project C. Such projects
frequently involve large commitments of cash in order to restore the land to its
original contours after the mine or quarry has been fully exploited.
As a general conclusion on IRR, we can say that if the opportunity cost of finance
is used as the hurdle rate, it will usually give the same signals as the NPV model.
Sometimes, though, IRR will give false, ambiguous or incoherent signals, which if
heeded could lead to sub-optimal decisions being made. It seems that IRR is a mathem-
atical result rather than a reliable decision-making technique. Usually, by coincid-
ence, it will give the right signal, but not always. There are means of modifying IRR to
overcome some of these problems, but is there any point in our doing so? NPV always
gives logical and clear signals and so we might as well use it as the primary assess-
ment method all the time.4.4 Payback period
The payback period technique asks the simple question: how long will it take for
the investment to pay for itself out of the cash inflows that it is expected to
generate?Figure 4.3
Graph of the NPV
against the discount
rate for Project D
The particular features of the cash flows of this project lead to its having no IRR.