How does Internal Rate of Return differ from Net Present Value? Please provide a comprehensive response...

How does Internal Rate of Return differ from Net Present Value?

Please provide a comprehensive response to this question.

Expert Solution

Net present value is used to discount the present value of expected cash inflows of a project. The initial investment deducted from these cash inflows will determine if we accept or reject a project. A project with a positive NPV shoyld be accepted and a project with negative NPV should be rejected.

The internal rate of return is the discount rate that makes NPV equal to zero. A project which has an IRR greater than cost of capital should be accepted and IRR with less than cost of capital should be rejected.

Cost of capital is the rate or return presumed for the reinvestment of intermediate cash flows. Under IRR, it is the internal rate of return.

The NPV method presents an outcome that forms the foundation for an investment decision, i.e, NPV method shows how much money can be made. The IRR method does not help in making this decision, since its percentage return does not tell the investor how much money will be made.

The discount rate used in NPV calculation can be difficult to arrive since management might want to adjust it with the risk levels. IRR method does not have this problem since it is the rate of return derived from underlting cash flows.

jeff jeffy answered 2 years ago

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