Module 7: The Decision Makers - NPV vs. IRR

In the corporate boardroom, the two dominant metrics are Net Present Value (the destination/total wealth) and Internal Rate of Return (the speedometer/efficiency) .

1. The NPV-IRR Conflict

While NPV and IRR generally agree on independent projects, they frequently clash when comparing "Mutually Exclusive Projects" (e.g., you only have the budget to build Factory A or Factory B) .

NPV is Absolute: It measures the total dollar amount of wealth created.
IRR is Relative: It measures the percentage return, which can heavily bias decisions toward small, fast-returning projects over massive, highly profitable ones.
The Reinvestment Flaw: IRR mathematically assumes interim cash flows are reinvested at the high IRR rate, which is often dangerously optimistic. NPV assumes cash flows are reinvested at the firm's standard Cost of Capital.

The Rule: If the metrics conflict, always trust NPV. You cannot pay dividends with percentages; you pay them with cash .

Case Study: Software Upgrade vs. Global Expansion A tech firm must choose between two projects. Project A (Server Upgrade) costs $100,000 and yields a 30% IRR, creating $20,000 in NPV. Project B (European Expansion) costs $5 Million and yields an 18% IRR, creating $1.5 Million in NPV.

Analysis: The CEO, obsessed with efficiency, wants Project A. The CFO overrides, selecting Project B. Even though the percentage return is lower, the absolute wealth creation (NPV) is vastly superior, maximizing shareholder value .

Self-Assessment Quiz

Explain the "Reinvestment Rate Assumption" flaw inherent in the IRR calculation.
Why must a CFO always defer to NPV over IRR when choosing between mutually exclusive projects?