IS NPV IS SUPERIOR TOIRRPresented By:-RamawatarTawaniya
Meaning of NPV The difference between the presentvalue of cash inflows and the presentvalue of cash outflows. NPV is used incapital budgeting to analyze theprofitability of an investment orproject.
Advantages of NPV NPV method, is a direct measure of thecontribution. It increases the wealth of the shareholders as it gives you money. The investment will increase the firmsvalue Considers all the cash flows Considers the time value of money Considers the risk of future cash flows Provides better forecast
Three properties of NPV Higher income amounts make the netpresent value higher If profits come sooner, the net presentvalue is higher. Changing the discount rate changesthe net present value.
IRR- Internal rate of return IRR on an investment or project is theannualized effective compoundedreturn rate or rate of return that makesthe NPV of all cash flow from aparticular investment equal to zero.
Advantages of IRR IRR is indicating a rate of return of aproject. IRR is sometimes referred to as "economicrate of return (ERR)". IRR method, it shows the return on theoriginal money invested. No need to calculate the cost of capital. Tell weather an investment increase thefirm value It calculates Break-even. IRR calculates an alternative cost of capitalincluding an appropriate risk premium
NPV calculated in terms of currency while IRR isexpressed in terms of the percentage The IRR Method cannot be used to evaluateprojects where there are changing in cash flows NPV calculate additional wealth IRR calculation is ineffective if a project with amixture of multiple positive and negative cash flow FlexibilitySuperiority of NPV over IRR
Conclusion NPV is better than IRR because apositive NPV indicates addition toshareholders wealth and negativeNPV indicates vie versa. This thumbrule cannot be applied to IRR.