NPV and IRR are both tools for evaluating investment returns, but they answer slightly different questions and can sometimes give conflicting signals.
NPV: value in dollars
NPV = −Investment + Σ [Cash Flow / (1 + r)^t]
NPV answers: "At my required rate of return, how many dollars of value does this investment create?" The result is an absolute dollar figure.
NPV is directly actionable: accept all positive-NPV projects. When comparing two projects, the one with higher NPV creates more wealth (assuming the same scale).
IRR: the break-even return rate
IRR is the discount rate at which NPV = 0. It answers: "What rate of return does this investment actually earn?" It's expressed as a percentage.
For the example project ($100k investment, $30k–$40k annual cash flows over 5 years), IRR ≈ 21.5%. This means the project earns 21.5% annually.
If your hurdle rate is 10%, IRR > 10% → accept. If hurdle rate is 25%, IRR < 25% → reject.
When NPV and IRR agree
For simple investments (one outflow, then inflows), NPV and IRR always agree on the accept/reject decision: - Positive NPV ↔ IRR > discount rate - Negative NPV ↔ IRR < discount rate
When they disagree: mutually exclusive projects
When choosing between two competing projects, NPV and IRR can give different rankings.
Example: - Project A: $100k investment, IRR 25%, NPV $20k at 10% - Project B: $500k investment, IRR 20%, NPV $80k at 10%
IRR favors Project A (25% > 20%). NPV favors Project B ($80k > $20k).
Which is correct? NPV wins. Project B creates $80k of wealth; Project A creates only $20k. IRR misleads because it ignores scale.
When NPV is always preferred
- Different scales: IRR ignores project size; NPV measures absolute value
- Non-conventional cash flows: Multiple sign changes in cash flow series can produce multiple IRR values — NPV has only one value
- Varying discount rates: If your cost of capital changes year to year, only NPV handles this correctly (use different discount rates per period)
When IRR is useful
IRR is intuitive for communication: "This project earns 21.5% annually" is easier to explain than "this project has $38k NPV at 10% discount rate."
It's also useful for comparing returns across investments of different sizes when combined with NPV analysis.
Best practice: Calculate both. Accept/reject on NPV. Use IRR for context and communication.
Use the NPV Calculator for your investment analysis.