The size of the investment significantly impacts the decision-making process in capital budgeting. Larger investments may offer higher returns, but they also come with higher risks and longer payback periods. Therefore, companies often calculate the Internal Rate of Return (IRR) for each project to determine which one provides a higher return on investment (ROI). This helps them to make informed decisions about where to allocate their capital.
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Imagine your company has two projects: Project A requires a $100,000 investment with expected cash flows of $30,000 annually for five years, while Project B requires a $50,000 investment with expected cash flows of $15,000 annually for five years. By calculating the IRR for each project, you can determine which project provides a higher return on investment, or ROI.