NPV Vs. IRR of a Project?

Both NPV and IRR are primarily used in capital budgeting, the process by which companies determine whether a new investment or expansion opportunity is worthwhile. Given an investment opportunity, a firm needs to decide whether undertaking the investment will generate net economic profits or losses for the company.To do this, the firm estimates the future cash flows of the project and discounts them intopresent value amounts using a discount rate that represents the project's cost of capitaland its risk. Next, all of the investment's future positive cash flows are reduced into one present value number. Subtracting this number from the initial cash outlay required for the investment provides the net present value (NPV) of the investment.Let's illustrate with an example: suppose JKL Media wants to buy a small publishing company. JKL determines that the future cash flows generated by the publisher, when discounted at a12% annual rate, yield a present value of $23.5 million. If the publishing company's owner is willing to sell for $20 million, then the NPV of the project would be $3.5 million ($23.5 - $20 = $3.5). The $3.5 million dollar NPV represents the intrinsic valuethat will be added to JKL Media if it undertakes this acquisition.So, JKL Media's project has a positive NPV, but from a business perspective, the firm should also know what rate of return will be generated by this investment. To do this, the firm would simply recalculate the NPV equation, this time setting the NPV factor to zero, and solve for the now-unknown discount rate. The rate that is produced by the solution is the project's internal rate of return (IRR).For this example, the project's IRR could, depending on the timing and proportions of cash flow distributions, be equal to17.15%. Thus, JKL Media, given its projected cash flows, has a project with a17.15% return. If there were a project that JKL could undertake with a higher IRR, it would probably pursue the higher-yielding project instead. Thus, you can see that the usefulness of the IRR measurement lies in its ability to represent any investment opportunity's return and to compare it with other possible investments.

In my opinion, there are instances where IRR and NPV may give conflicting results. As explained in detail in the previous answer, IRR is merely the cap rate at which NPV equals zero. Now, from a mathematical standpoint, cashflows (in and out) generated by an investment can be represented by a polynomial function graph, and this graph can cross the x-axis more than once, meaning that it can have more than one IRR. For Instance, an investment that requires cash-out at the beginning but also during the project's life cycle would lead to two different IRRs. Therefore, theoretically, a negative NPV can have an attractive IRR.

Personally, I never trust an IRR alone. I always try to couple it with the NPV.

I hope this answers your question.