Master the NPV and IRR: Two metrics that determine whether your investment fails or succeeds

Imagine you have $100,000 to invest and two projects promise profits. Both sound good, but which one should you choose? This is where many investors get stuck: superficial analysis. The reality is that the Net Present Value (NPV) and the Internal Rate of Return (IRR) are the only reliable judges to determine whether a project will generate real profits or leave you with losses. The problem: these indicators can often contradict each other. A project may look better in NPV but worse in IRR, or vice versa. Understanding both is the difference between an informed decision and a financial disaster.

Why are NPV and IRR so important for your investment decision?

Decision-making in investments requires more than intuition. NPV and IRR are fundamental tools that allow investors and companies to assess whether a project has real profitability potential or if it’s just an illusion of attractive numbers.

NPV answers the question: How much net money will my investment actually generate in terms of present value? IRR, on the other hand, answers: At what annual return rate does my money effectively grow? These are different questions that require complementary answers.

Deciphering NPV: the metric of absolute value

Net Present Value is the financial approach to determine if an investment generates more cash than it costs. In practical terms, it calculates the present value of all expected future cash flows, subtracts the initial investment cost, and the result indicates whether the project is viable.

How does it work? Future income and expenses of the project are projected, a discount rate (which represents the opportunity cost of capital) is selected, and all these flows are discounted to the present. If the result is positive, the investment will generate profits. If negative, it will probably bring losses.

The NPV formula explained