IS NPV IS SUPERIOR TO IRR

Meaning of NPV The difference between the present value of cash inflows and the present value of cash outflows. NPV is used in capital budgeting to analyze the profitability of an investment or project. 

Advantages of NPV NPV method, is a direct measure of the contribution. It increases the wealth of the share holders as it gives you money. The investment will increase the firm's value Considers all the cash flows Considers the time value of money Considers the risk of future cash flows Provides better forecast

Three properties of NPV  Higher income amounts make the net present value higher If profits come sooner, the net present value is higher.  Changing the discount rate changes the net present value.  

IRR- Internal rate of return IRR on an investment or project is the annualized effective compounded return rate or rate of return that makes the NPV of all cash flow from a particular investment equal to zero.

Advantages of IRR IRR is indicating a rate of return of a project. IRR is sometimes referred to as "economic rate of return (ERR)". IRR method, it shows the return on the original money invested. No need to calculate the cost of capital. Tell whether an investment increase the firm value It calculates Break-even. IRR calculates an alternative cost of capital including an appropriate risk premium

Similarities of NPV over IRR Both NPV and IRR are time adjusted methods of measuring investment networth.

Superiority of NPV over IRR Rate of Interest: The NPV methods takes the rate of interest as a known factor whereas the IRR method takes it as unknown factor. From a comparison of NPV and IRR, it can be seen that NPV is actually a better measure than IRR, especially, in long term projects, not only because NPV considers different discount rates but also takes into account the cost of capital.

Superiority of NPV over IRR NPV calculated in terms of currency while IRR is expressed in terms of the percentage The IRR Method cannot be used to evaluate projects where there are changing in cash flows NPV calculate additional wealth where IRR does not calculate additional wealth. IRR calculation is ineffective if a project with a mixture of multiple positive and negative cash flow

Superiority of NPV over IRR If cash flows are changing, IRR method cannot be used and while NPV can be used. NPV method is more Flexible than IRR method

Conclusion NPV is better than IRR because a positive NPV indicates addition to shareholder's wealth and negative NPV indicates vie versa. This thumb rule cannot be applied to IRR.

In conclusion, NPV is a better method for evaluating mutually exclusive projects than the IRR method.   The NPV method employs more realistic reinvestment rate assumptions, is a better indicator of profitability and shareholder wealth, and mathematically will return the correct accept-or-reject decision regardless of whether the project experiences non-normal cash flows or if differences in project size or timing of cash flows exist.