Question

In what ways is IRR more useful than NPV? In what ways is NPV more useful than IRR? Or you could view this question as asking for the pros and cons of each calculation.

Answer 1

NPV strengths:
1. it factors in time value of money
2. It includes risk involves in generating cash flow/.
3. It is good in evaluating project involving large investment is of large scale projects.
4. Here reinvestment rate is discount rate or WACC which is lower than IRR.
5. It helps in ranking between projects.
Weakness:
1. it is sensitive to discount rate. Faulty calculation of discount rate can distort the results.
2. Cash flow prediction is sometimes subjective leading to variance with actual NPV.

Assumptions:
1. the reinvestment rate is same as WACC and is reinvested at higher or lower rate.
2. If two projects are equally risky, their reinvestment-rate is the same

IRR:
Advantages:
1. Includes time value of money.
2. Good in accepting independent projects.

Disadvantages
1. Is not good for acceptability with large scale projects where it might be rejected when comparing with small scale project if IRR is higher.
2. IRR and NPV may conflict in certain case where NPV rule Prevails.
3. IRR rate is higher than WACC generally so reinvestment as higher than WACC may not be possible always.
4. It gives multiple IRR when have more than one negative cash flows occur in the project

Assumptions:
1.Reinvestment rate is same as IRR which may not be practical.
2. Two different projects, even if equally risky, have two different reinvestment-rates