 Net Present Value Decision Rules
 IRR (Internal Rate of Return)
 in Project Management
The two most-used measures for evaluating projects are
the net present value and the internal rate of return!
Be able to use computer generated information
for decision making in an organisation
AC : 4.3- Use Financial tools for decision
making
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Net present value
IRR
NPV versus IRR
Link to Project Management
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
The difference between the present value of the future cash flows from
an investment and the amount of investment. Present value of the expected
cash flows is computed by discounting them at the required rate of return.
Where,
N=total number of periods
T= the time of the cash flow
i= the discount rate (the rate of return that could be earned on an investment)
Rt = the net cash flow i.e. cash inflow – cash outflow at time t (R0: it is
subtracted from the whole as any initial investments during first year is not
discounted for NPV purpose)
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If NPV>0, accept the Project.
If NPV=0, accept or reject the
Project.
If NPV<0, reject the Project.
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An Investment of $1,000 in year 1
 The discount rate is 10%
 In Year 2, we receive $110 in year 2
 You expect to receive $1,200 in year 3
1
2
3
Investment
($ 1,000)
Cash Inflows
$0
$ 110
$ 1200
Discounting
Factor
1
1.10
1.21
Discounted
Cash Inflow
0
$ 100
$ 991.74
Therefore, NPV= ($ 1,000) + $ 100 + $ 991.74= $ 91.74
Hence, we can do this investment.
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Internal Rate of Return
• The internal rate of return of a project is
known as the rate of return where the
particular project’s net present value
equals to zero.
• Formula:
– CF: Cash Flow
– r: Internal Rate of Return
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In IRR decisions, if we have only one project,
most of the time we need the basic rule
«independent project»:
return)
IRR > Cost of capital (should be accepted)
IRR = Cost of capital (provides the minimum
IRR < Cost of capital (shouldn’t be accepted)
In addition, we need to take other situations
into account too. Especially, eventhough NPV
and IRR will generally give us the same decision,
there are some exceptions:
• Nonconventional cash flows – cash flow signs
change more than once
• Mutually exclusive projects
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If we want to decide on to accept the project or
not, we should consider the comparison of IRR &
cost of capital for an individual project.
In this example;
• when the cost of capital is 15%, then the NPV is
-227,53 (don’t accept)
• Alternative: IRR < Cost of capital
• when the cost of capital is 10%, then the NPV is
34,27 (accept)
• Alternative: IRR > Cost of capital
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Key differences:
• NPV Method is preferred over other methods since it calculates additional wealth and
the IRR Method does not
• The IRR Method is more used in evaluating short-term projects and NPV is more used
in evaluating long-term projects.
• one significant advantage of IRR -- managers tend to better understand the concept of
returns stated in percentages and find it easy to compare to the required cost of capital
• Applying NPV using different discount rates will result in different recommendations.
The IRR method always gives the same recommendation.
compare two mutually
exclusive projects
Project A
Project B
Invest
-10.000
-25.000
Return
+25.000
+50.000
IRR
IRR 150%
IRR 100%
NPV by i=8%
13.148
21.296
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NPV and IRR in the decision taking process
Methods to evaluate a project
 estimate
the value of the project
 choosing which project gets priority
By applying
 NPV
as time value of money (money figure)
 IRR calculate the investments profitability as an interest
rate –also known as opportunity cost /cost of
capital(percentage figure)
included in a business case prepared by the
controlling department
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Thanks
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