Interpretation of the relationship between Internal rate of return and net present value: improving the accuracy of Investment decision

When making investment decisionsForumbingoInvestors usually pay attention to the projectForumbingoThe benefits and risks of. Internal rate of return (Internal Rate of Return)Forumbingo, IRR) and net present value (Net Present Value)Forumbingo, NPV) are two important indicators to evaluate the investment benefit of the project. Understanding the relationship between the two indicators will help investors to make more accurate decisions.

Internal rate of return (IRR)

The internal rate of return refers to the discount rate that makes the net present value of the project equal to zero. In other words, IRR is the annualized rate of return that investors expect from the project without considering the value of time. The formula for calculating IRR is as follows:

By solving the equation, the discount rate r which makes NPV equal to zero is found, that is, IRR.

Net present value (NPV)

The net present value is the difference between the present value converted into the future cash flow of the project according to a certain discount rate and the initial investment cost of the project. The calculation formula of NPV is:

When the NPV is greater than 00:00, it means that the income of the project exceeds the cost, and the investment is feasible; when the NPV is less than 00:00, the income of the project is not enough to cover the cost, and the investment is not feasible.

The relationship between IRR and NPV

It can be seen from the calculation formula that IRR and NPV are interrelated. When IRR is greater than the discount rate set by investors, NPV will be greater than zero; on the contrary, when IRR is less than the set discount rate, NPV will be less than zero. Therefore, IRR and NPV can be used together when evaluating the investment benefit of the project.

For example, assuming that the discount rate set by investors is 10%, and the calculated IRR of the project is 12%, then the NPV of the project will be greater than zero, and the investment is feasible. If the IRR is 8%, which is lower than the discount rate of investors, then the NPV of the project will be less than zero, and the investment is not feasible.

In practical application, investors also need to consider other factors, such as cash flow stability of the project, market risk and so on. However, mastering the relationship between IRR and NPV is of great significance to improve the accuracy of investment decisions.