Internal Rate of Return – Internal Rate of return is the rate at which an investment is repaid by the proceeds from the project. Mathematically, it is regarded as the rate of return at which the present value of cash inflows equals the present value of cash outflows. The IRR so calculated is compared with the required rate of return. The required rate of return is the minimum rate at which investor expects the firm will earn profit. If IRR is less than the required rate of return then the project is rejected otherwise accepted. Therefore, accepting the project with higher IRR will increase the wealth of the investors. It is expressed in percentage terms and does not help in decision making. A variation in the timing of cash outflow results in the various values of IRR which in turn makes difficult for decision making.
Comparing NPV and IRR – IRR May not be consistent to the Shareholders wealth maximization when compared to NPV
Both the methods are consistent with the objective of maximizing shareholders wealth. But two are not in correspondence with one another.
1. Mutually Exclusive Projects – If there are two independent projects, then the IRR and NPV will provide the same ranking and result and will increase the wealth of the shareholders. But in case of mutually exclusive projects, both the methods provide different rankings and IRR may not provide the ranking which may increase the wealth of the shareholders.
2. Multiple Rates of Return – The IRR method is affected by one major discrepancy that the method sometimes gives multiple rates of return for different projects. It happens when there is frequent increase or decrease in the cash inflows or sudden infusion of capital into the project.
3. Issue of Assumption of Reinvestment Rate - NPV assumes that the cash flows generated by the given project are reinvested at the cost of capital and IRR assumes that the cash flows generated are reinvested at the IRR. Thus, IRR assumption is based on the contingency of cash inflows and outflows of the given projects. As far as the rate of return is considered as the opportunity rate, the NPV method is more accurate though conservative but applies consistently to all projects.
Illes M., 2012, “Links between Net Present Value and Shareholder Value from a Business Economic Perspective”, Retrieved from accessed on 07-06-2016.
Edwards G, 2010, “Comparing NPV and IRR”, Retrieved from accessed on 07-06-2016.