Question

What is the difference between NPV and IRR? Which one would you choose for evaluating a potential investment and why? Be sure to support your reasoning with evidence

Answer 1

NPV or net present value discounts the stream of expected cash flows associated with a proposed project to their current value. The difference between the company's present value of cash inflows and outflows will present a cash surplus or loss for the project.

IRR or internal rate of return estimates the profitability of potential investments using a percentage value rather than a dollar amount. Unlike NPV, it excludes outside factors such as capital costs and inflation. It simplifies the project to a single number to determine if the project is viable or not.

Putting the difference here below-

Using any of the two methods totally depends on the project. Both IRR and NPV can be used to determine how desirable a project will be and whether it will add value to the company. Some prefer using IRR as a measure of capital budgeting, it does come with problems because it doesn't take into account changing factors such as different discount rates. In these cases, it is beneficial to use net present value.