Question

How can Net Present Value and IRR be interpreted, and how to apply them in practice. Can you explain in several ways and give some examples to explain this question.

Answer 1

Net present value refers to the present value of net cash flows of a project over a period of time.

The cash flows are expressed in present terms using a given discount factor.

A project is accepted if NPV > 0, else rejected.

Coming to IRR, the internal rate of return refers to the rate of return yielded by the given cash flow series. It is the interest rate at which NPV = 0

A project is accepted if IRR > MARR, else rejected

Example,

Cash flow series is given with values for years 0-5

-10000 , 3000 , 3000 , 3000 , 3000 , 3000

MARR = 10%

NPV = -10,000 + 3000(P/A,10%,5)

NPV = $2987

Since NPV is positive, project must be accepted as it would give profits to the investor.

Coming to IRR

IRR can be calculated in Excel as: =IRR(-10000,3000,3000,3000,3000,3000)

IRR = 15.24%

Since IRR > MARR, the project must be accepted.