⚔️capital-budgeting
NPV vs IRR
NPV vs IRR
Two core methods used in capital budgeting. NPV gives dollar value; IRR gives percentage return.
Comparison Table
| Feature | NPV | IRR |
|---|---|---|
| Output | Dollar amount of value created | Percentage return |
| Decision rule | Accept if > 0 | Accept if > hurdle rate |
| Scale sensitivity | Handles different project sizes well | Can mislead with different scales |
| Multiple solutions | Always one answer | Can have multiple IRRs with non-conventional flows |
| Reinvestment assumption | Reinvest at WACC (realistic) | Reinvest at IRR (often unrealistic) |
Key Differences
- →NPV gives dollar value added; IRR gives percentage return
- →NPV always has a unique answer; IRR may have multiple solutions
- →NPV handles scale correctly; IRR can favor smaller projects
When to Use NPV
- ✓Primary decision rule for accept/reject
- ✓Comparing mutually exclusive projects
- ✓Any standard capital budgeting decision
When to Use IRR
- ✓Communicating returns to non-finance stakeholders
- ✓Supplementary metric alongside NPV
- ✓Quick screening when cash flows are conventional
Common Confusions
- !Assuming higher IRR always means a better project
- !Treating IRR as the actual return (it depends on reinvestment assumption)
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FAQs
Common questions about this comparison
Lead with NPV as the primary metric, then mention IRR as a supplement.
For a single project, they always agree. Conflicts arise when ranking mutually exclusive projects.