Comparative Analysis of NPV and IRR in Capital Budgeting Decisions

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Cost
Management

Table of Content
O Introduction
O Net Present Value
O Advantages and Disadvantages of
NPV
O Example of NPV
O Internal Rate of Return
O Advantages and Disadvantages of
IRR
O NPV Vs IRR
O Conclusion

Introduction
O Capital expenditure decision tools
helps in appraising an investment
and making decisions
O It includes tools such as Net Present
Value, Internal Rate of Return,
Payback period etc.

Net Present Value
O Net Present Value helps in determining the
present value of series of flow of cash which are
occurring at different time frame.
O NPV is computed by reducing present value of
cash outflow from present value of cash inflow.

Advantages &
Disadvantages of NPV
O Advantages:
O Consideration of
time value of
money
O Maximize the
value of firm
O Consideration of
all types of cash
flows
O Disadvantages:
O Not feasible if
duration of two
projects is
different
O Ignoring Sunk
Cost
O Difficulty in
judging cash
flows

Example of NPV
O NPV is computed using following
formula:
NPV= PV of Cash Inflow- PV of Cash
Outflow

Internal Rate of Return
O IRR is used for estimation of
profitability of proposed investment
O IRR is a discount rate at which NPV
of all the cash flows are equal to zero
O IRR is computed using following
formula:

Advantages &
Disadvantages of IRR
O Advantages:
O Time Value of
money
considered
O Easy to interpret
O No need for
finding required
rate of return
O Disadvantage:
O Ignores
economies of
scale
O Involves
complicated
calculations

NPV Vs IRR
Serial
Number
Basis NPV IRR
1 Computatio
n
Computed
in money
value
Computed
in
percentage
2 Purpose Profit/
Surplus
from
project
Breakeven
situation
3 Measure Absolute
Measure
Relative
Measure
4 Discount
Rate
Change
Change in
NPV
Same
result even
if discount
rate
changes

Conclusion
O Both NPV and IRR are used for
making capital decisions.
O Out of both NPV is favorable if profit
from project is to be computed
O IRR is favorable to compute
breakeven for a project

References
O Leyman, P., & Vanhoucke, M. (2017). Capital-and
resource-constrained project scheduling with net
present value optimization. European Journal of
Operational Research, 256(3), 757-776.
O corporatefinanceinstitute (2019). Internal Rate of Return
(IRR) - A Guide for Financial Analysts. [online] Corporate
Finance Institute. Available at:
https://corporatefinanceinstitute.com/resources/knowled
ge/finance/internal-rate-return-irr/ [Accessed 24 Jul.
2019].
O Bragg, S. (2019). The difference between NPV and IRR.
[online] AccountingTools. Available at:
https://www.accountingtools.com/articles/the-difference-
between-npv-and-irr.html [Accessed 24 Jul. 2019].