Question

Differentiate between NPV (Net Preset Value) and IRR (Internal rate of Return). If you are using IRR to evaluate your projects, how would you rank the different projects that you are evaluating?

Answer 1

Answer:

Difference between Net Present Value & Internal Rate of Return:

Net Present Value (NPV):

Net present value (NPV) explains the total benefit that which we will have after investing in a project form start to end, it is a discounted method that considers the time value of money in the evaluation of the various proposal.

Net Present Value (NPV)= Present value of cash inflow-Present Value of Cash Outflow

We can calculate the Net Present Value as follows:

Particulars	Period	Present Value Factor	Amount	Present Value
Cash Inflow (A)				XXXX
Cash Outflow (B)				XXXX
NPV (A-B)				XXXX

Decision:

If NPV >=0	Accept the proposal
If NPV<0	Reject the proposal

When we have multiple projects consider the project having higher NPV.

Internal Rate of Return (IRR):

It is the exact actual percentage at which the projects have actually earned considering the time value of money, at IRR, NPV is always Zero. it is also a method to rank the various proposal using NPV.

IRR=Lower Rate+ (NPV of Lower Rate/ difference in NPV)x Difference in rate

NPV is a better method for evaluation of the mutually exclusive projects, Mutually exclusive projects are those which result in rejection of one if another is selected.

While using the IRR technique to evaluate a project we should rank the project based on the rate of return on investment, if discount rate exceeds the project cost project will be accepted otherwise rejected.