Analyze investment opportunities with comprehensive IRR and NPV calculations. Evaluate capital budgeting decisions using internal rate of return, net present value, profitability index, and payback period analysis for informed investment choices.
IRR and NPV are cornerstone metrics in capital budgeting and investment analysis. They help investors and managers evaluate project profitability, compare investment alternatives, and make informed financial decisions based on time value of money principles.
NPV = ฮฃ [CFt รท (1+r)^t] - Initial Investment
NPV represents the dollar amount of value created or destroyed by an investment. It's the gold standard for investment decisions.
0 = ฮฃ [CFt รท (1+IRR)^t] - Initial Investment
IRR is the discount rate that makes NPV equal to zero. It represents the project's effective annual return rate.
MIRR = (FV of Inflows รท PV of Outflows)^(1/n) - 1
MIRR addresses IRR's reinvestment assumption by using a specific reinvestment rate for positive cash flows.
PI = PV of Inflows รท Initial Investment
PI shows the ratio of payoff to investment. It's particularly useful when capital is limited (capital rationing).
| Metric | Accept Rule | Reject Rule | Best For | Limitations |
|---|---|---|---|---|
| NPV | NPV > $0 | NPV < $0 | Standalone projects, mutually exclusive choices | Requires accurate discount rate |
| IRR | IRR > Required return | IRR < Required return | Independent projects, communication | Multiple solutions, reinvestment assumption |
| MIRR | MIRR > Required return | MIRR < Required return | Projects with mixed cash flows | Requires reinvestment rate assumption |
| PI | PI > 1.0 | PI < 1.0 | Capital rationing, efficiency ranking | Ignores project scale |
| Payback | Payback < Target | Payback > Target | Liquidity assessment, simple screening | Ignores time value, cash flows after payback |
Company considering $500,000 equipment purchase:
Rental property investment analysis:
IT system modernization project:
Projects of different sizes may rank differently by IRR vs NPV:
| Project | Investment | NPV | IRR |
|---|---|---|---|
| Large | $1,000,000 | $200,000 | 15% |
| Small | $100,000 | $50,000 | 35% |
NPV says: Choose Large project (+$200k value)
IRR says: Choose Small project (35% vs 15%)
Projects with different cash flow timing patterns:
When IRR and NPV conflict, generally prefer NPV because:
When investment capital is limited:
Testing robustness of investment decisions:
Flexibility value in investment timing:
Determining the appropriate discount rate:
Select single project, comparison, or sensitivity analysis
Input initial cash outflow as negative value
Enter required rate of return or cost of capital
Enter projected cash flows for each period
Optional rate for MIRR calculation
Review NPV, IRR, and other metrics for decision
Use NPV as the primary decision criterion, especially for mutually exclusive projects
Consider multiple metrics (NPV, IRR, PI, payback) for comprehensive analysis
Be cautious with IRR for non-conventional cash flows (multiple sign changes)
Perform sensitivity analysis on key assumptions and variables
Use risk-adjusted discount rates that reflect project-specific risks