Difference Between NPV vs IRR
NPV vs IRR in this article it is stated. NPV is the short form used for Net Present Value whereas IRR is the short form used for the Internal Rate of Return. Net present value or NPV can be defined as a method used to ascertain the present value (P.V.) of upcoming cash flows that can be earned from a particular project. IRR or internal rate of return, on the other hand, can be defined as a discount rate that lets the net present value of cash inflows from a particular project equal to 0. Net present value method is generally used for the purpose of evaluating projects that are supposed to continue for a longer period of time whereas the internal rate of return method is more often used for the purpose of evaluating projects that are supposed to continue for a shorter span of time.
Head to Head comparison Between NPV vs IRR (infographics)
Below are the Top 15 Differences NPV vs IRR:
Key Differences Between NPV vs IRR
The key differences between NPV vs IRR are discussed below:
- The net present value method is an absolute sum whereas the internal rate of return method is a relative sum.
- If the cash flow changes, the net present value can be taken into use whereas the internal rate of return cannot be taken into use.
- If the Net present value of a project is positive then the same can be accepted. On the other hand, a project in IRR can be accepted if its internal rate of return is higher than its weighted average cost of capital.
- The net present value method is the PV of cash flows whereas the internal rate of return method is the discount rate that makes the net present value of cash flow equal to zero.
- The net present value method can evaluate additional wealth whereas the internal rate of return method cannot evaluate additional wealth.
- The net present value method is a flexible method whereas the internal rate of return method is inflexible.
- In an NPV method, intermediate cash inflows and outflows can be reinvested at a cut off rate whereas, in an IRR method, intermediate cash inflows and outflows are assumed to be reinvested at IRR.
- NPV method is suitable for projects that are supposed to continue for a longer span of time whereas the IRR method is suitable for projects that are supposed to continue for a shorter span of time.
- NPV method considers the rate of interest as a known factor whereas the IRR method considers the rate of interest as an unknown factor.
- NPV of a project is determined and expressed as a currency or monetary return while IRR of a project is determined and expressed in the form of percentage return.
NPV vs IRR Comparison Table
Let’s discuss the top comparison between NPV vs IRR:
| Basis of comparison | NPV | IRR |
| Full form | The full form for NPV is Net Present Value. | The full form for IRR is the Internal Rate of Return. |
| Definition | NPV may be defined as difference arrived when the present value of the cash outflows is deducted from the present value of cash inflow. | IRR can be defined as the discount rate that can make the net present value of all the cash inflow equal to 0. |
| Calculation | Net Present Value is calculated in the form of currency or monetary return. | Internal Rate of Return is calculated in the form percentage return. |
| Measure | Absolute measure. | Relative measure. |
| Evaluation of projects when there are constant movements in cash flows. | NPV method can be used for the evaluation of projects/ investment plans even when there is a constant movement in cash flows. | IRR method cannot be taken into use for the evaluation of projects when there is a constant movement in cash flows that is when there is a combination of negative and positive cash flows. |
| Flexibility | Flexible. | Not that flexible. |
| Additional wealth | Net Present Value method can evaluate additional wealth. | Internal Rate of Return method cannot evaluate additional wealth. |
| ROI or rate of interest | The net present value method considers ROI to be a known factor. | The internal rate of return method does not consider ROI to be a known factor. |
| Suitability with respect to the tenure of the projects. | The net present value method is suitable with respect to the projects that are supposed to continue for a longer duration of time. | The internal rate of return method is suitable with respect to the projects that are supposed to continue for a shorter span of time. |
| Receptivity | The net present value method can be easily understood by the public. | The internal rate of return method can be easily understood by the business managers only. |
| Acceptance of the project | In this method, if NPV of a project comes out to be positive then the same can be accepted. | In this method, if r>k then the project can be accepted. |
| Market ROI (rate of interest) | The net present value method recognizes the significance of the cost of capital or market ROI. | The internal rate of return method does not recognize the market ROI. |
| Assumption | The net present value method assumes that the cash inflows and outflows are reinvested at the required ROR (Rate of return). | The internal rate of return assumes that the cash inflows and outflows are reinvested at the internal rate of return. |
| Calculation | The net present value method calculates the actual amount of investment. | The internal rate of return method calculates maximum ROI. |
| Purpose | The net present value method is concerned with project surpluses. | The internal rate of return method is more concerned about break-even cash flows of a particular project. |
Conclusion
Net present value can be evaluated by calculating the difference between the present value of the cash inflows and the present value of the cash outflows. The net present value takes the time value of money into consideration. The net present value method is used for the purpose of evaluating investment plans or projects where there is a possibility of fluctuations in cash flows.
On the other hand, the internal rate of return method cannot be taken into use for the evaluation of projects that have fluctuation in cash flows. Net present value is a flexible method and it can be easily understood by the public at large whereas the internal rate of return is inflexible and it can only be understood by business managers. Net present value can even evaluate additional wealth while on the other hand, the internal rate of return cannot evaluate additional wealth.
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