Difference Between NPV and IRR
Let assume that your organization has asked you to do an analysis — Whether the new project will be beneficial?
Content: NPV Vs IRR
Net Present Value is the calculation of present value of cash inflows minus present value of cash outflows, where present value defines what will be the worth of future sum of money as of today. You can use this approach as an alternative method to NPV.
This method entirely depends on estimated cash flows as it is a discount rate which tries to make NPV of cash flows of a project equal to zero. XYZ Company planning to invest in a plant, it generates the following cash flows. And suggest whether the XYZ Ltd. Should invest in this plant or not. As I can conclude that if you are evaluating two or more mutually exclusive projects so better go for NPV method instead of IRR method.
Even you can make use of IRR method it is a great complement to NPV and will provide you accurate analysis for investment decisions. So many concepts are getting more cleared than it had been all these years.
The reasons of conflict amidst the two are due to the variance in the inflows, outflows, and life of the project. IRR is described as a rate at which the sum of discounted cash inflows equates discounted cash outflows.
Expressed in Absolute terms Percentage terms What it represents? Surplus from the project Point of no profit no loss Break even point Decision Making It makes decision making easy.
It does not help in decision making Rate for reinvestment of intermediate cash flows Cost of capital rate Internal rate of return Variation in the cash outflow timing Will not affect NPV Will show negative or multiple IRR. NPV shows the actual benefit received over and above from the investment made in the particular project for the time and risk.
The calculation of NPV can be done in the following way:. IRR for a project is the discount rate at which the present value of expected net cash inflows equates the cash outlays.
To put simply, discounted cash inflows are equal to discounted cash outflows. In this method, the cash inflows and outflows are given. The calculation of the discount rate, i. IRR, is to be made by trial and error method. The decision rule related to the IRR criterion is: Moreover, if the IRR and Cut off rate are equal, then this will be a point of indifference for the company.
So, it is at the discretion of the company, to accept or reject the investment proposal. Net Present Value and Internal Rate of Return both are the methods of discounted cash flows, in this way we can say that both considers the time value of money. Similarly, the two methods, considers all cash flows over the life of the project.