What is the relationship between Internal Rate of Return and Net Present Value?

Answer 1

the Internal rate of return is the discount rate in the NPV formula which makes NPV equal to 0. It is kind of the breakeven point for the NPV analysis. Though IRR is a relative measure and not an absolute measure like the NPV. Also there is a problem where a capital investment appraisal results in multiple IRR's Calculation of IRR This is done via linear interpolation

Answer 2

Well NPV says about the value remain with you today by taking an investment decision of say n years.it gives the value in terms of RS. or $.

where as IRR says only in terms of percentage.

The advantage of NPV is that is increases the wealth of the share holders.as it gives you money.

Where as IRR is indicating a rate of return of a project.

with the help of IRR one can find the discount rate at which the total amout received on the investment is equal to the investment that is made today.one would be at no risk of loosing the money as the required rate of return should be equal to or higher then the IRR.

NPV only gives an indication of the value of the money today but nobody knows the exect Rate of Return OF a project so IRR gives you the RATE at which you are safe.where in NPV a discount rate is assumeed. reguards

Anant Pattjoshi

MBA(Finance)

Cosmic Business School

New Delhi-44 Net Present Value Advantages Tells whether the investment will increase the firm's value Considers all the cash flows Considers the time value of money Considers the risk of future cash flows (through the cost of capital) Disadvantages Requires an estimate of the cost of capital in order to calculate the net present value Expressed in terms of dollars, not as a percentage

Internal Rate of Return Advantages Tells whether an investment increases the firm's value Considers all cash flows of the project Considers the time value of money Considers the risk of future cash flows (through the cost of capital in the decision rule) Disadvantages Requires an estimate of the cost of capital in order to make a decision May not give the value-maximizing decision when used to compare mutually exclusive projects May not give the value-maximizing decision when used to choose projects when there is capital rationing Cannot be used in situations in which the sign of the cash flows of a project change more than once during the project's life

Younes Aitouazdi: University of Houston Downtown