NPV

NPV is the present value of a series of cash inflows and outflows, adjusted for the time value of money

IRR

IRR is the discount rate at which the NPV of an investment equals zero

Calculation of NPV and IRR

NPV is calculated using the formula NPV = Σ (R_t / (1+i)^t) - C, while IRR is solved for by setting the NPV equal to zero and solving for 'i'

Significance of NPV and IRR

NPV and IRR are critical financial metrics used to assess the profitability of investment projects

Differences between NPV and IRR

NPV provides a dollar value of the expected monetary gain, while IRR offers a percentage return and is useful for ranking projects when capital is limited

Contextual Differences in Application

NPV is preferred for projects with large capital outlays and when comparing projects with different cash flow patterns, while IRR is useful for understanding efficiency and comparing profitability of projects of different scales

Principle of Time Value of Money

NPV and IRR are intertwined through the principle of the time value of money, which recognizes that a dollar today is worth more than a dollar in the future

Relationship between NPV and IRR

IRR is the rate that equates the present value of an investment's cash inflows with its outflows, resulting in an NPV of zero

Complementary Use of NPV and IRR

NPV provides a measure of value in currency, while IRR indicates the rate of return, making them complementary tools for evaluating investment opportunities

Application in Decision-Making

NPV and IRR are essential for strategic investment decisions, with NPV being valuable for assessing incremental value and IRR for evaluating efficiency and comparing profitability against the company's hurdle rate

Rules Governing NPV and IRR

The NPV rule states that an investment should be undertaken if it has a positive NPV, while the IRR rule posits that an investment is acceptable if its IRR exceeds the required rate of return