How should I decide between NPV and IRR when both are available?
In project analysis questions, I often calculate both NPV and IRR and then wonder which one the answer should emphasize. Are they interchangeable for CFA Level I?
For an independent project with conventional cash flows, the accept/reject decision is usually the same. Accept the project when NPV is positive at the required return, or when IRR is above the required return.
The interpretation is different:
- NPV tells you the amount of value added at the required return.
- IRR tells you the discount rate that makes NPV equal zero.
Suppose Northstar Labs invests USD 250,000 and expects inflows of USD 70,000, USD 85,000, USD 95,000, and USD 110,000. At a 9 percent required return, NPV is about USD 37,047 and IRR is about 15.09 percent. Both measures say the project is acceptable.
If projects are mutually exclusive, rely on NPV more heavily because it measures value added directly. IRR can rank projects poorly when scale or timing differs.
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