In capital budgeting, there are a number of different approaches that can be used to evaluate any given project, and each approach has its own distinct advantages and disadvantages.
All other things being equal, using internal rate of return (IRR) and net present value (NPV) measurements to evaluate projects often results in the same findings. However, there are a number of projects for which using IRR is not as effective as using NPV to discount cash flows. IRR's major limitation is also its greatest strength: it uses one single discount rate to evaluate every investment.
Although using one discount rate simplifies matters, there are a number of situations that cause problems for IRR. If an analyst is evaluating two projects, both of which share a common discount rate, predictable cash flows, equal risk, and a shorter time horizon, IRR will probably work. The catch is that discount rates usually change substantially over time. For example, think about using the rate of return on a Tbill in the last 20 years as a discount rate. Oneyear Tbills returned between 1% and 12% in the last 20 years, so clearly the discount rate is changing.
Without modification, IRR does not account for changing discount rates, so it's just not adequate for longerterm projects with discount rates that are expected to vary. (To learn more, read Taking Stock Of Discounted Cash Flow, Anything But Ordinary: Calculating The Present And Future Value Of Annuities and Investors Need A Good WACC.)
Another type of project for which a basic IRR calculation is ineffective is a project with a mixture of multiple positive and negative cash flows. For example, consider a project for which marketers must reinvent the style every couple of years to stay current in a fickle, trendy niche market. If the project has cash flows of $50,000 in year one (initial capital outlay), returns of $115,000 in year two and costs of $66,000 in year three because the marketing department needed to revise the look of the project, a single IRR can't be used. Recall that IRR is the discount rate that makes a project break even. If market conditions change over the years, this project can have two or more IRRs, as seen below.
Thus, there are at least two solutions for IRR that make the equation equal to zero, so there are multiple rates of return for the project that produce multiple IRRs. The advantage to using the NPV method here is that NPV can handle multiple discount rates without any problems. Each cash flow can be discounted separately from the others.
Another situation that causes problems for users of the IRR method is when the discount rate of a project is not known. In order for the IRR to be considered a valid way to evaluate a project, it must be compared to a discount rate. If the IRR is above the discount rate, the project is feasible; if it is below, the project is considered infeasible. If a discount rate is not known, or cannot be applied to a specific project for whatever reason, the IRR is of limited value. In cases like this, the NPV method is superior. If a project's NPV is above zero, then it is considered to be financially worthwhile.
So, why is the IRR method still commonly used in capital budgeting? Its popularity is probably a direct result of its reporting simplicity. The NPV method is inherently complex and requires assumptions at each stage  discount rate, likelihood of receiving the cash payment, etc. The IRR method simplifies projects to a single number that management can use to determine whether or not a project is economically viable. The result is simple, but for any project that is longterm, that has multiple cash flows at different discount rates, or that has uncertain cash flows  in fact, for almost any project at all  simple IRR isn't good for much more than presentation value.
For more information on capital budgeting, see Spotting Profitability With ROCE.

What is the formula for calculating internal rate of return (IRR) in Excel?
Understand how to calculate the internal rate of return (IRR) using Excel and how this metric is used to determine anticipated ... Read Answer >> 
What is the relationship between the hurdle rate (MARR) and the Internal Rate of ...
Find out how companies and managers use hurdle rate, or MARR, and internal rate of return, or IRR, to evaluate projects and ... Read Answer >> 
How do you use discounted cash flow to calculate a capital budget?
Learn how discounted cash flows are used in creating capital budgets as a part of the net present value and internal rate ... Read Answer >> 
How much debt is too much when calculating capital budgeting?
Learn how companies determine how much debt is acceptable when funding a new project by using the net present value to estimate ... Read Answer >> 
Why is the Modified Internal Rate Of Return (MIRR) preferable to the regular internal ...
See why the modified internal rate of return is often a superior metric to the classic internal rate of return for assessing ... Read Answer >> 
What is the benefit of the Modified Internal Rate Of Return (MIRR)?
Find out why the modified internal rate of return metric tends to be more realistic than the classic internal rate of return ... Read Answer >>

Fundamental Analysis
Return on Investment (ROI) Vs. Internal Rate of Return (IRR)
Read about the similarities and differences between an investment's internal rate of return (IRR) and its return on investment (ROI). 
Term
Internal Rate of Return Formula for Excel
The internal rate of return, or IRR, is a popular metric businesses use to measure a project’s return on investment. 
Investing Basics
Capital Budgeting: The Capital Budgeting Process At Work
This tutorial will conclude with some basic, yet illustrative examples of the capital budgeting process at work. Example 1: Payback PeriodAssume that two gas stations are for sale with the following ... 
Insurance
How to Compare Permanent Life Insurance Policies
How you can use the internal rate of return to compare and purchase a permanent life insurance policy. 
Economics
Modified Internal Rate of Return (MIRR)
Modified internal rate of return (MIRR) is a variant of the more traditional internal rate of return calculation. 
Stock Analysis
The WorryFree Options Strategy With A Perfect Record
The S&P 500 has been on fire in 2013  up an impressive 30%.But the question I'm getting the most from readers right now is, "Is the market about to correct?" It's not hard to see why. The ... 
Fundamental Analysis
Top 3 Pitfalls Of Discounted Cash Flow Analysis
The DCF method can be difficult to apply to reallife valuations. Find out where it comes up short. 
Professionals
10 Ways to Improve Cash Flow in Construction
Improving cash flow in construction requires some sectorspecific strategies. 
Professionals
Project Manager: Career Path & Qualifications
Learn more about what project managers job, the qualifications necessary for the position and the most common careers for these professionals. 
Investing Basics
Discounting With The Discount Rate
The discount rate is the interest rate you need to earn on a given amount of money today to end up with a given amount of money in the future. Let's say you need $1,000 one year from now to go ...

Internal Rate Of Return  IRR
A metric used in capital budgeting measuring the profitability ... 
IRR Rule
A measure for evaluating whether to proceed with a project or ... 
IRR
The currency abbreviation or currency symbol for the Iranian ... 
Pooled Internal Rate Of Return  PIRR
A method of calculating the overall internal rate of return (IRR) ... 
Net Present Value  NPV
Net Present Value (NPV) is the difference between the present ... 
Hurdle Rate
The minimum rate of return on a project or investment required ...