Question

How are Net Present Value(NPV) and Internal Rate of Return (IRR) similar? How do they differ?

Answer 1

The internal rate of return (IRR) calculates the percentage rate of return at which those same cash flows will result in a net present value of zero. It used to determine the attractiveness of the Project.

The Net Present Value (NPV) results in the total net cash inflows expected from a project at the present value using a discounting factor. This is used to quantify the results in value terms from the entire project, covering all the cashflows from the project.

Both these techniques consider the entire life of project, unlike the Payback period which considers the life of proejct only till the recoverabiliy of the initial investment.

IRR and NPV , both considers the timing of the cash flows in a project; However, IRR provides a % return and NPV provide the real dollar (currency) value. Further, NPV considers and results in the value, based on the assumption that the cashflows during the life of the project are reinvested at the cost of capital of the entity.

While most of the times NPV and IRR result in the same outcome, there shall be cases of conflicting opinions as well; Incase of analysis of a single conventional project, both NPV and IRR might provide same indicator on the evaluation of the project or not. However, while comparing two projects, the NPV and IRR may provide conflicting results. Hence, these need to be considered as evaluation tools and the final judgement shall be taken based on various other aspects as well; A project with lower IRR, however, more longevity might be more beneficial for an entity with a project with higher IRR with shorter life span; Many factors contribute the overall evaluation