Net Present Value ( NPV)

The Net Present Value (NPV) of an investment (project) is the difference between the sum of the discounted cash flows, which are expected from the investment, and the amount, which is initially invested. It is a traditional valuation method (often for a project) used in the Discounted Cash Flow measurement methodology, whereby the following steps are undertaken:

1. calculation of expected free cash flows (often per per year) that result out of the investment

2. subtract /discount for the cost of capital (an interest rate to adjust for time and risk)

The intermediate result is called: Present Value.

3. subtract the initial investments

The end result is called: NPV.

Alternative Method of Calculating NPV is,

Where,

t - the time of the cash flow

r - the discount rate (the rate of return that could be earned on an investment in the financial markets with similar risk.)

C_t - the net cash flow (the amount of cash, inflow minus outflow) at time t (for educational purposes, C₀ is commonly placed to the left of the sum to emphasize its role as the initial investment.).

So NPV is an amount that expresses how much value an investment will result in. This is done by measuring all cash flows over time back towards the current point in present time.

If the NPV method results in a positive amount, the project should be undertaken.

Internal Rate of Return (IRR)

The internal rate of return (IRR) is a metric used by firms to decide whether they should make Investment It is an indicator of the efficiency of an investment, as opposed to net present value (NPV), which indicates value or magnitude.

In Simple words, The Internal Rate of Return ( IRR) is the discount rate that results in a net present value of zero for a series of future cash flows. It is a Discounted Cash Flow (DCF) approach to valuation and investing just as Net Present Value (NPV). Both IRR and NPV are widely used to decide which investments to undertake and which investments not to make.

The IRR is the true interest yield expected from an investment expressed as a percentage.