Question 4.RQ.3: Research indicates that the IRR method is extremely popular ...
Research indicates that the IRR method is extremely popular even though it has shortcomings when compared with the NPV method. Why might managers prefer to use IRR rather than NPV when carrying out discounted cash flow evaluations?
The IRR method does appear to be preferred to the NPV method among many practising managers. The main reasons for this appear to be as follows:
■ A preference for ratios expressing a percentage return rather than an absolute figure as a means of expressing the outcome of a project. This preference for a ratio may arise because other financial goals of the business are often set in terms of ratios: for example, return on capital employed.
■ A preference for ranking projects in terms of their percentage return. Managers may feel it is easier to rank projects on the basis of percentage returns (though NPV outcomes should be just as easy for them). We saw in the chapter, however, that the IRR method could provide misleading advice on the ranking of projects.