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Rs.10,000 5 Years Return at the end of project 6,418 4,990 1,900 2,251 2,500 18,059 12.55%
12.55% =IRR(Year0:Year5)
IRR = CAGR
Finatics
Rs.10,000 10.00% 5 Years Return at the end of project 5,856 4,659 1,815 2,200 2,500 17,030 11.24%
Finatics
What is NPV?
The NPV method discounts operating cash flows at a rate that captures the cost of capital (i.e. the capital used/contributed to generate cash flows). The NPV method aims to capture the amount available after meeting the cost of all capital contributors (all claimholders). In fact, the NPV method is what leads to the concept of value creation through Economic Profit. Thus even if the IRR of Project A is better than Project B, a relatively lower Cost of Capital may swing the decision in favor of Project B. In Short: A positive NPV is a must and the higher the better. The relationship between NPV and IRR is that IRR is the rate at which NPV = Zero When Cost of Capital is more than IRR the NPV will be Negative Note: Discounting/Compounding is beyond the scope of this article
Year 0 Year 1
Investment Horizon
P res ent Value of Cas h Flows 3,636 2,893 1,127 1,366 1,552 10,574 574
Formula us ed =4,000 x 0.909 =3,500 x 0.826 =1,500 x 0.751 =2,000 x 0.683 =2,500 x 0.621 =SUM(3,636:1,552) =10,574 - 10,000
Finatics
Download: the supporting Excel file here. You may also like to read this related article by Mckinsey & Co.