Question

Class what are Net Present Value (NPV) and Internal Rate of Return (IRR) and how do they link to our discussion of cost/benefit analysis?

Answer 1

Net present value is defined as quantitative method of measuring cost and benefits of a project. It involves comparing present value of inflow with present value of outflow and then deciding on the viability of the project.

NPV= 0 means the cost and benefit from the project are equal.

NPV>0 means benefits are higher than cost.

NPV<0 means costs are higher than benefits.

IRR is quantitative method to identify the required rate of return from project under which NPV = 0. While calculating NPV value we need to assume the discount rate which is not practical when interest rates are fluctuating. IRR provides a good alternate to identify the rate where costs are covered from the project though at that rate financial objectives of the organization may not be met.