NPV vs IRR: Which to Use and When
By Devon Coombs, CPA, MBA · Assistant Teaching Professor of Finance, Santa Clara University · Reviewed October 2026
From the author: Devon Coombs, CPA, MBA teaches finance at Santa Clara University and works with corporate teams on practical AI.
Finance questions & answers · Student career guide · AI training for finance teams · Consulting · The 10 Laws of Finance
Use net present value (NPV) to estimate dollar value created at a required return. Internal rate of return (IRR) is the discount rate that makes NPV zero. For mutually exclusive projects with comparable risk and no binding capital constraint, prefer the higher NPV. A higher percentage return can still create fewer dollars of value.
| NPV | IRR | |
|---|---|---|
| What it measures | Present value of inflows minus outflows at a chosen discount rate | The discount rate that makes NPV equal zero |
| Units | Dollars today | Return per cash-flow period; annual for annual periods |
| Required inputs | Cash amounts, timing, and a required return appropriate to risk | Cash amounts and timing; a hurdle rate is used separately to evaluate the result |
| Project scale | Shows how many dollars of value are created | A smaller project can have a higher percentage return |
| Unusual cash flows | One value at the chosen discount rate | Cash flows with multiple sign changes may have multiple IRRs or no usable IRR |
When NPV is the right tool
Use NPV when comparing mutually exclusive investments and evaluating the dollars added after allowing for time and risk. If money is rationed, consider the feasible combination of projects rather than ranking individual projects mechanically. Different lifetimes or risks also need a consistent comparison framework.
When IRR is the right tool
Use IRR to summarize a cash-flow stream as a percentage and compare a conventional investment with its appropriate hurdle rate. A conventional pattern has an initial outflow followed by inflows. Match the period, cash-flow definition, and financing basis before comparing IRRs.
The common mistake
Do not treat the highest IRR as automatically the best investment, or interpret IRR as guaranteed compound growth of all your money. Computing IRR does not require actual reinvestment of distributions; computing NPV does not require those distributions to be reinvested at the discount rate. If you want terminal wealth, explicitly model what happens to interim cash flows.
Why a 20% IRR can create more value than a 30% IRR
- Project A costs $100 today and returns $130 in one year. IRR = 30%; at a 10% required return, NPV = $130 ÷ 1.10 − $100 = $18.18.
- Project B costs $1,000 today and returns $1,200 in one year. IRR = 20%; at the same 10% required return, NPV = $1,200 ÷ 1.10 − $1,000 = $90.91.
- If you can choose only one, both have comparable risk, and you can fund either, B creates $72.73 more present value despite its lower IRR.
IRR compares percentages. NPV captures the dollars created. These one-year projects have no interim distributions, so the ranking difference here comes from scale, not reinvestment.
References & further reading
Work the numbers yourself
Both concepts are taught in depth, with practice questions, in the free Real Estate Finance course.