NPV vs IRR: What's the Difference?
Net Present Value (NPV) and Internal Rate of Return (IRR) are both methods used to evaluate the profitability of a real estate investment, but they answer different questions:
Net Present Value (NPV) and Internal Rate of Return (IRR) are both methods used to evaluate the profitability of a real estate investment, but they answer different questions:
Aspect | NPV (Net Present Value) | IRR (Internal Rate of Return) |
---|---|---|
Definition | The difference between the present value of cash inflows and outflows over time | The discount rate at which the NPV of all cash flows (in and out) equals zero |
What It Tells You | The dollar amount you gain or lose based on your required return | The annualized rate of return the investment is expected to generate |
Decision Rule | Invest if NPV > 0 (i.e., investment exceeds your return requirement) | Invest if IRR > required rate of return |
Considers Size of Return? | Yes – gives a dollar figure, so larger projects show larger NPVs even with lower IRRs | No – a high IRR on a small project might not be better than a lower IRR on a big one |
Preferred For | Absolute profit measurement; comparing across projects with different scales | Comparing investment efficiency or growth rate of return |
Drawbacks | Depends on a discount rate you must estimate | Can be misleading if there are multiple IRRs (non-normal cash flows) |
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