Question

What can you say about NPV with respect to project valuation (As an alternative to IRR)? When are projects valuable as measured by NPV?

Answer 1

NPV or Net Present Value is used when the decision to invest in a project needs the actual value addition from investing in the project. IRR provides the inherent rate of return for a project when the NPV of cash flows equal to zero. While both metrics are used in evaluating projects, the use if NPV is generally preferred for the following reason.

For comparing projects with different investment outlay ie having different quantum of investments, the IRR and NPV may provide different results. An IRR of a much smaller project would be higher than a larger project. While the NPV of the larger project would be much bigger. For the company to enhance value or Value per share NPV is preferred as the company's primary purpose is value maximization for the shareholders.

In case of uneven and multiple negative cash flows, there can be multiple IRR's and such cases would not yield a definite decision making parameter. NPV is preferred in such cases over IRR.