Should you use NPV or IRR to choose between the two projects?

Both NPV and IRR are widely used in capital budgeting to analyse profitability of an investment or project. Both of them are discounted cash flow models and can reach similar conclusions about a single project. They are easy to understand in terms of decision criteria i.e. Accept project if positive NPV or vice versa, accept the project with the higher IRR.

Unlike IRR, NPV considers different discount rates and takes into account cost of capital. Thus may involve a lot of calculation work. IRR would always give the same recommendation even if the discount rates change.This may be favourable among non-financial managers as it involves less work, less confusing and easier understanding by expressing in percentage terms.

IRR is limited and could not be use in the event of changing cash flows i.e. Negative and positive cashflows in between periods.Whereas NPV can be calculated in the event of changing cash flows.

There are however limitations to the assumptions for NPV where it assumes that the discount rate is stable over the life of a project.

Academic suggest that NPV is preferred over IRR as it calculates additional wealth while IRR does not.