The CFA material states that NPV is the preferred method because it’s a better guage. But wouldn’t IRR be a more conservative approach, because it can also serve as a sensitivity (how high does discount have to go before we no longer make a profit). Sometimes NPV can be greater with a lower IRR, meaning the project is less certain. Or am I understanding incorrectly?
IRR - is only a rate. Are you going to say that some one with say a 10% rate of return is better than one with a 8% rate or return, even conservatively?
NPV - is however a Net Amount - and henec is comparable. Someone providing more NPV is directly contributing to the bottom line of the company.
Besides IRR does not work for projects with unconventional cash flows.
IRR is completely meaningless outside of that, in general, higher IRR will imply higher NPV for the same project. It’s a horrific measure, and it’s misleading because it doesn’t reflect any real rate in the market.
NPV provides you with a dollar amount that, as long as your discount rates are accurate, will indicate exactly how beneficial the project is. IRR can never do this, and IRR is size independent – a project with an IRR of 70% might have a NPV of $3 while another project with an IRR of 15% could have an NPV of $999,999,999.
NPV is more realistic in a way it assumpes the proceeds are reinvested at ‘r’ whereas IRR assumes proceeds reinvested at IRR. Moreover we could have No IRR or Multi IRR problems. In individual projects IRR and NPV breed the same result but in mutually exclusive projects the result could be conflicting. Regarding your argument, NPV gives the amount to which the shareholders wealth is maximized, which is ultimately the objective. Suppose a project is giving 10% IRR but the value it is adding is less than a project giving 8% IRR. We should choose the one which adds maximum value to the shareholders’ wealth.