17 Pages Posted: 5 May 1997
Date Written: October 1995
Discounted Cash Flow (DCF) includes the present value (PV) (or net present value (NPV)) and the internal rate of return (IRR) methods of analyzing cash flows. DCF provides insight into financial management not possible using other techniques. The NPV of the time-phased costs over the economic life of an investment project is the best single-number measure of its life-cycle cost. NPV is used extensively. IRR is used much less so, then only with considerable unwarranted caution. The major reason for IRR not being used centers on the extensive criticism of IRR found in corporate finance and financial management textbooks. These criticisms overstate the minor difficulties associated with IRR, understate the coexistent difficulties with NPV, and are the focus this paper. The aim is to put the criticisms of IRR into perspective and put the two DCF measures into balance. This paper critically examines the professed reasons for the superiority of NPV over IRR in financial decision making.
JEL Classification: G31, G32, G11
Suggested Citation: Suggested Citation
By Jan Jacobs