NPV and IRR: Net Present Value (NPV) and Internal Rate of Return (IRR) are both methods used to evaluate the potential of an investment, but they approach it differently. NPV measures the overall value an investment will generate by calculating the present value of all future cash flows and subtracting the initial investment cost. It provides a clear monetary figure showing the profit or loss.
In contrast, IRR determines the discount rate at which the investment's net present value becomes zero, essentially showing the break-even point. It gives the annual percentage return expected from the investment. While both metrics are useful in assessing investments, NPV focuses on the actual cash value, whereas IRR highlights the rate of return. Let's delve deeper into the differences between NPV and IRR for CA Exams .Also Check: Difference Between Accounting and Economic Profit
Difference Between NPV and IRR | ||
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Aspect | Net Present Value (NPV) | Internal Rate of Return (IRR) |
Definition | Calculates the net value an investment generates by subtracting the initial investment from the present value of future cash flows. | Finds the annual percentage return at which an investment breaks even (when NPV equals zero). |
Measurement | Expressed in monetary terms (e.g., ₹, $). | Expressed in percentage terms (%). |
Perspective | Shows the net value of the investment over its entire life. | Indicates the annual return rate over the investment’s life. |
Dependency on Rate | Requires a discount rate for calculation. | Does not require a specified discount rate. |
Decision Criterion | A positive NPV indicates a good investment. | An IRR higher than the required rate of return indicates a good investment. |
Multiple Solutions | Always provides a single solution. | Can yield multiple solutions in specific scenarios. |
Ease of Comparison | Less intuitive when comparing different investments. | More intuitive for comparing different investments. |