Complete Guide To Corporate Finance


Net Present Value And Internal Rate Of Return - Advantages And Disadvantages Of NPV and IRR

Now that you're familiar with both NPV and IRR and understand the shortcomings of PB period and ARR, let's compare the advantages and disadvantages of NPV and IRR. Advantages:

  • The NPV method is a direct measure of the dollar contribution to the stockholders.
  • The IRR method shows the return on the original money invested.


  • The NPV method does not measure the project size.
  • The IRR method can, at times, give you conflicting answers when compared to NPV for mutually exclusive projects. The "multiple IRR problem" can also be an issue, as discussed below.

The Multiple IRR Problem
A multiple IRR problem occurs when cash flows during the project lifetime are negative (i.e. the project operates at a loss or the company needs to contribute more capital).

This is known as a "non-normal cash flow," and such cash flows will give multiple IRRs.

Why Do NPV and IRR Methods Produce Conflicting Rankings?
When a project is an independent project, meaning the decision to invest in a project is independent of any other projects, both the NPV and IRR will always give the same result, either rejecting or accepting a project.

While NPV and IRR are useful metrics for analyzing mutually exclusive projects - that is, when the decision must be one project or another - these metrics do not always point you in the same direction. This is a result of the timing of cash flows for each project. In addition, conflicting results may simply occur because of the project sizes.

The timing of cash flows as well as project sizes can produce conflicting results in the NPV and IRR methods.

Example: NPV and IRR Analysis
Assume once again that Newco needs to purchase a new machine for its manufacturing plant. Newco has narrowed it down to two machines that meet its criteria (Machine A and Machine B), and now it has to choose one of the machines to purchase. Further, Newco has assumed the following analysis on which to base its decision:

We first determine the NPV for each machine as follows:

NPVA = ($5,000) + $2,768 + $2.553 = $321

NPVB = ($10,000) + $5,350 + $5,106 = $456

According to the NPV analysis alone, Machine B is the most appropriate choice for Newco to purchase.

The next step is to determine the IRR for each machine using our financial calculator. The IRR for Machine A is equal to 13%, whereas the IRR for Machine B is equal to 11%.

According to the IRR analysis alone, Machine A is the most appropriate choice for Newco to purchase.

The NPV and IRR analysis for these two projects give us conflicting results. This is most likely due to the timing of the cash flows for each project as well as the size difference between the two projects.

Profitability Index
Related Articles
  1. Budgeting

    Your Worst Financial Mistakes And Why You Made Them

    No one intends to make a financial mistake, but an unexpected disaster or poor planning could leave you in financial distress.
  2. Bonds & Fixed Income

    An Assessment of High Yield Corporate Bond Credit Spreads

    A credit risk literature review.
  3. Personal Finance

    4 Ways Simple Interest Is Used In Real Life

    Simple interest works in your favor when you're a borrower, but against you when you're an investor.
  4. Investing

    Is it Time to “Buy” Inflation?

    Based on recent data from the Treasury-Inflation Protected Securities (TIPS) market, it would seem that most investors aren’t worried about inflation.
  5. Economics

    Explaining Appreciation

    Appreciation refers to an increase over time in the value of an investment or asset.
  6. Economics

    Calculating Long-Term Debt to Total Assets Ratio

    A company’s long-term debt to total assets ratio shows the percentage of its assets that are financed with long-term debt.
  7. Economics

    Explaining Like-for-Like Sales

    Companies use like-for-like sales figures to compare sales volume from one period to another.
  8. Investing

    How Worried Should We Be About China?

    An economic slowdown, a freezing up in trade and plunging markets and currencies are casting a shadow across Asia—and the globe. How worried should we be?
  9. Technical Indicators

    Explaining Autocorrelation

    Autocorrelation is the measure of an internal correlation with a given time series.
  10. Term

    Public Goods & Free Riders

    A public good is an item whose consumption is determined by society, not individual consumers.
  1. Put-Call Parity

    A principle that defines the relationship between the price of ...
  2. Encumbrance

    A claim against a property by a party that is not the owner. ...
  3. Alpha

    Alpha is used in finance to represent two things: 1. a measure ...
  4. Capitalization Rate

    The rate of return on a real estate investment property based ...
  5. Profit and Loss Statement (P&L)

    A financial statement that summarizes the revenues, costs and ...
  6. Linear Relationship

    A statistical term used to describe the directly proportional ...
  1. What should I study in school to prepare for a career in corporate finance?

    Depending on which area you want to specialize in, corporate finance can be one of the most competitive fields in business. ... Read Full Answer >>
  2. Why would a company issue preference shares instead of common shares?

    Preference shares, or preferred stock, act as a hybrid between common shares and bond issues. As with any produced good or ... Read Full Answer >>
  3. What is the difference between cost of debt capital and cost of equity?

    In corporate finance, capital – the money a business uses to fund operations – comes from two sources: debt and equity. While ... Read Full Answer >>
  4. What is the difference between gross profit, operating profit and net income?

    The terms profit and income are often used interchangeably in day-to-day life. In corporate finance, however, these terms ... Read Full Answer >>
  5. Do dividends affect working capital?

    Regardless of whether cash dividends are paid or accrued, a company's working capital is reduced. When cash dividends are ... Read Full Answer >>
  6. Do prepayments provide working capital?

    Prepayments, or prepaid expenses, are typically included in the current assets on a company's balance sheet, as they represent ... Read Full Answer >>

You May Also Like

Hot Definitions
  1. Ex Works (EXW)

    An international trade term requiring the seller to make goods ready for pickup at his or her own place of business. All ...
  2. Letter of Intent - LOI

    A document outlining the terms of an agreement before it is finalized. LOIs are usually not legally binding in their entirety. ...
  3. Purchasing Power

    The value of a currency expressed in terms of the amount of goods or services that one unit of money can buy. Purchasing ...
  4. Real Estate Investment Trust - REIT

    A REIT is a type of security that invests in real estate through property or mortgages and often trades on major exchanges ...
  5. Section 1231 Property

    A tax term relating to depreciable business property that has been held for over a year. Section 1231 property includes buildings, ...
  6. Term Deposit

    A deposit held at a financial institution that has a fixed term, and guarantees return of principal.
Trading Center
You are using adblocking software

Want access to all of Investopedia? Add us to your “whitelist”
so you'll never miss a feature!