Question

Explain in detail under what circumstances the Net Present Value (NPV) and Internal Rate of Return (IRR) could provide different decisions. Which method would you follow in the case of such inconsistent conclusions?

Answer 1

NPV and IRR provide different decisions under following conditions:
1.When cash flows have multiple change in signs of cash flows IRR and NPV may conflict.
2. Based on the scale of project or cash flows IRR and NPV may conflict.
3. Timing of cash flows also create differences in IRR and NPV decision making.

In case of conflicting suggestion NPV should be used to accept or reject the project.
NPV is better because it can be possible to calculate the present value of cash flows which have multiple changes in the signs of cash flow. It incorporates size of investment and scale of project. IRR fails in projects based on scale,timing of cash flows and cash flows having multiple changes in sign of cash flow