NPV vs. IRR: How to Tell If an Investment Project Is Worth It

What Is NPV (Net Present Value)?

Imagine someone offers to hand you $1,000 exactly one year from today. That promise isn't worth $1,000 to you right now. You'd have to wait, you carry the risk they don't pay, and meanwhile that money could have been invested somewhere else. So the promise is worth something less than $1,000 today.

Net Present Value takes every dollar a project will produce in the future, shrinks each one back to what it's worth today, adds them all up, and subtracts what you have to pay upfront. Whatever is left over is the value the project creates.

Why a dollar next year is worth less than a dollar today

The shrinking factor is your discount rate — roughly, the return you could earn on a comparable alternative investment. At a 10% discount rate, $1,000 received a year from now is worth $1,000 ÷ 1.10 = $909.09 today. Two years out, you divide twice: $1,000 ÷ 1.10² = $826.45. The further away the money, the harder it gets discounted.

The formula, now that the idea is clear

What does a negative NPV actually mean?

A common misreading: negative NPV does not mean the project loses money. It means the project doesn't clear the bar you set with your discount rate. A project can be profitable in accounting terms and still have a negative NPV, because the capital would have done better elsewhere. If NPV is negative at a 10% discount rate, you're saying: this earns less than 10%, and I have 10% alternatives. NPV of exactly zero isn't a failure either — it means the project earns precisely your required return, no more, no less.

What Is IRR (Internal Rate of Return)?

IRR flips the question around. Instead of asking "what is this project worth at a 10% discount rate?", it asks: what discount rate would make this project exactly break even? That break-even rate is the project's own internal rate of return.

It's the project's built-in speed. If a project's IRR is 15.6%, then the capital sitting inside that project is compounding at 15.6% a year. Compare that to what your money costs — if your cost of capital is 10% and the project runs at 15.6%, you're ahead by a comfortable margin.

Is a higher IRR always better?

No, and this is the single most expensive misunderstanding in early-career finance. IRR is a percentage, and percentages are blind to size. A project returning 50% on $1,000 makes you $500. A project returning 14% on $500,000 makes you $70,000. The second one has a far worse IRR and is obviously the better business decision if you can only do one and you have the capital. IRR tells you about efficiency per dollar invested; it says nothing about how many dollars you got to invest.

A Complete Worked Example, Step by Step

A small company is considering buying a machine. It costs $50,000 today and is expected to generate these net cash flows over five years. The company's required return (discount rate) is 10%.

Step 1 — Discount each cash flow back to today

Divide each year's cash flow by 1.10^t, where t is the year number.

Notice what happened to year 5: $8,000 of real cash shows up as only $4,967 of value today. That's the whole point of discounting — distance in time is expensive.

Step 2 — Subtract the initial investment to get NPV

Positive NPV. The machine is expected to add about $6,700 of value in today's dollars, over and above the 10% return the company already demands. On this criterion alone: buy it.

Step 3 — Find the IRR by trial and error

Now we hunt for the discount rate that drives NPV to zero. We know NPV is +$6,702 at 10%, so the break-even rate must be higher. Test some candidates:

IRR ≈ 15.6%. The machine earns about 15.6% a year on the money tied up in it, against a 10% required return — a cushion of roughly 5.6 percentage points before the project stops being worth doing.

Step 4 — Read the two numbers together

NPV says the project creates $6,702 of value. IRR says it runs at 15.6% against a 10% hurdle. Both point the same way, which is the normal case. A third number worth having beside them: payback period. Cumulative cash flow reaches zero partway through year 3 (−$50,000 + $15,000 + $18,000 + $20,000), so payback lands at about 2.85 years. Payback ignores the time value of money entirely, so it's never the deciding metric — but it does tell you how long your capital is exposed.

Running all three by hand on your own numbers gets old fast. You can plug an initial investment and a stream of cash flows into our NPV, IRR and payback calculator and get NPV, IRR and payback in one pass, which is also a fast way to sanity-check your spreadsheet formulas.

NPV vs. IRR: Side by Side

When Do NPV and IRR Disagree?

For a single yes/no decision on one project, they never really disagree: if IRR is above your discount rate, NPV is positive, and vice versa. Conflict only shows up when you're choosing between mutually exclusive projects — one machine, one site, one budget. Two things cause it.

Cause 1 — Difference in scale

Two projects, cost of capital 10%:

• Project A: invest $10,000 today, receive $12,000 in one year → IRR 20%, NPV $909
• Project B: invest $100,000 today, receive $115,000 in one year → IRR 15%, NPV $4,545

A wins on IRR by five full points. B makes you five times more money. If you have the $100,000 and can only do one, B is the right call — 20% of a small thing is a small thing.

Cause 2 — Difference in timing

The subtler case: two projects cost the same, but one front-loads its cash and the other back-loads it. Front-loaded cash flows produce a high IRR because the money comes back fast. Back-loaded cash flows produce more total value — but only if your discount rate is low enough that distant money still counts for something.

The widget below shows exactly this. Both projects cost $20,000. Drag the discount rate and watch which one is worth more.

So which one wins?

NPV. When the two conflict on mutually exclusive projects, NPV is the one to follow, for three reasons:

1. It measures what you actually care about — how much wealth the decision creates, in currency, not in percentage points.
2. Its reinvestment assumption is honest. NPV assumes intermediate cash flows get reinvested at your discount rate. IRR implicitly assumes they get reinvested at the IRR itself — so a project with a 40% IRR is quietly assuming you have an endless supply of 40% opportunities to roll the cash into.
3. NPVs add up; IRRs don't. The NPV of a portfolio of projects is the sum of their NPVs. You cannot add or average IRRs in any meaningful way.

Which doesn't make IRR useless. It's the number people remember in a meeting, it needs no discount rate to compute, and it tells you how much your rate assumption can be wrong before the answer flips. Use IRR to communicate and stress-test; use NPV to decide.

Why Can a Project Have Two IRRs — or None at All?

Because IRR is the root of a polynomial, and a polynomial can have several roots. If your cash flows change sign more than once — say a mine that costs money upfront, produces cash for years, then costs money again at the end for site restoration — the NPV curve can cross zero more than once. Two sign changes, potentially two IRRs, both mathematically valid and neither meaningful.

Conversely, a project whose NPV never crosses zero has no real IRR at all. Spreadsheet functions will return an error or an arbitrary nearby root. NPV has no such failure mode: it always returns exactly one number for a given discount rate. If your cash flows flip sign more than once, stop reporting IRR and report NPV.

What Discount Rate Should I Use?

This choice moves the answer more than anything else in the model, so it deserves more than a round number pulled from the air. The standard starting point is the company's weighted average cost of capital (WACC) — the blended cost of its debt and equity, weighted by how much of each it uses. If the project is riskier than the company's typical business, add a premium on top.

You can work out the blended figure with from your own debt and equity costs, then run the project itself at that rate. And because the rate is an estimate, always test a range: if NPV stays positive from 8% to 14%, the decision is robust. If it flips at 9.5%, your conclusion is really a bet on the discount rate, and you should say so out loud.

A Short Checklist Before You Present the Number

• Are the cash flows incremental — only what changes because of the project?
• Did you exclude sunk costs? Money already spent is irrelevant to the decision.
• Did you exclude interest payments from the cash flows? Financing cost lives in the discount rate; counting it twice is a classic error.
• Are cash flows and discount rate consistent — both nominal, or both real?
• Did you run a sensitivity range on the discount rate and on the biggest revenue assumption?
• Are you comparing projects of similar lifespans? A 3-year and a 10-year project aren't directly comparable on raw NPV.

The Takeaway

NPV and IRR answer two different questions about the same cash flows: how much value, and at what rate. Most of the time they agree, and when they do, the decision is easy. When they conflict — different project sizes, different cash timing — NPV is the tiebreaker, because dollars of value created is the thing you're actually trying to maximize. Keep IRR beside it as the number that travels well in conversation and shows you how much room for error you have.

Run your own project through it

Enter your initial investment and yearly cash flows to get NPV, IRR and payback period at once — plus a sensitivity view across discount rates. Free, no sign-up, runs in your browser.