Difference Between NPV and IRR
|
Aspect |
NPV |
IRR |
|---|---|---|
|
Calculation |
NPV figures out how much an investment adds or subtracts by comparing what money comes in now with what goes out later. |
IRR calculates the percentage rate of return by finding the discount rate where the total money coming in equals the total going out. |
|
Formula |
Net Present Value = Cash flow / (1 + i) ^ t – Initial Investment |
Internal Rate of Return = ((Future Value / Present Value) ^ (1 / No. of Periods)) – 1 |
|
Reinvestment Assumption |
NPV thinks the money coming in gets reinvested at the discount rate. |
IRR thinks the money coming in gets reinvested at the IRR itself. |
|
Preference in Decision Making |
NPV is better when comparing different-sized projects or with a stable cost of money. |
IRR might like smaller projects with higher returns, no matter their size or risk. |
|
Handling of Discount Rates |
NPV can deal with many discount rates, useful for projects with changing rates. |
IRR can give multiple rates for odd cash flows, making decisions tricky. |
|
Decision Criteria |
Projects with positive NPV are usually good investments. |
Projects with IRR higher than the cost of capital are usually considered profitable. |
|
Ranking of Projects |
NPV ranks projects based on their direct values, making comparison easier. |
IRR’s ranking might be tricky, especially when comparing different projects. |
|
Clarity of Measure |
NPV gives a clear idea of how much an investment is worth. |
IRR gives an idea of the return rate but may not show the exact value added. |
Difference between NPV and IRR
In finance, there are two important ways to check if an investment is a good idea: Net Present Value (NPV) and Internal Rate of Return (IRR). NPV looks at the money you’ll get back from an investment compared to what you put in, while IRR figures out the percentage return you’ll get. NPV tells you how much money you’ll make or lose, while IRR tells you the percentage of profit. Both NPV and IRR help people decide if an investment is worth it or not. They’re like tools to see if an investment will make money or not.