🏢 Corporate Issuers

NPV Formula & IRR Formula — How to Calculate Net Present Value

NPV and IRR formulas explained step by step. Net present value vs internal rate of return — when to use each, decision rules, and CFA Level 1 practice questions.

Key Concepts

Net Present Value (NPV)

Sum of PV of all cash flows (including initial investment). Accept if NPV > 0. The theoretically best capital budgeting method.

Internal Rate of Return (IRR)

Discount rate that makes NPV = 0. Accept if IRR > required return. May conflict with NPV for mutually exclusive projects.

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Formulas

From this module

NPV

NPV = Σ CFt/(1+r)t - Initial Investment

Where: r = required return (WACC for firm projects)

IRR

NPV = 0 = Σ CFt/(1+IRR)t

Where: IRR = rate where NPV equals zero

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Master Formula Sheet -- Corporate Issuers

NPV

NPV = Σ[CFₜ / (1+r)ᵗ] - Initial Investment

Accept if NPV > 0

IRR

Rate where NPV = 0

Accept if IRR > required return

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Decision Frameworks

NPV vs IRR: which to follow?

Use when:

  • NPV: always correct ranking for mutually exclusive projects
  • IRR: useful for communication (percentage return is intuitive)

Avoid when:

  • Following IRR when it conflicts with NPV — NPV maximizes shareholder wealth
  • Using IRR with non-conventional cash flows (multiple IRRs possible)

Test Your Understanding

When NPV and IRR give conflicting rankings for mutually exclusive projects, an analyst should:

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