IRR & NPV

I learned about these two things today. Very interesting stuff for the evaluation of a long term project. In my rudimentary mind, this is my explanation for them:

NPV, Net Present Value, is a sum of future cash flow, within a set period of time, as projected using a certain percentatge return. In other words, we have the cash flows, we set the percentage return, and we find out the present cash value. NPV has to be larger than 0 in order for a project to be eligible for comparison. Because being larger than 0 means that it is sufficient to cover for the initial investment and the opportunity cost (the percentage we set). The percentage is usually derived from a combination of investor’s equity (times by rate of return as epxectede by investors (usually by historical value)), and borrowed equity (times by interest), or just the WACC, Weighted Average Cost Of Capital.

IRR, or internal rate of return, is essentially NPV set to 0. We have the initial investment, and we want to see if the forecast cash flow can satisfy our requirement for return. Therefore, the higher the IRR, the better.

This is my ridiculously erroneous and simplistic view of these two concepts.

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