← Business Metric: Financial (all topics)
NPV, IRR & payback period
What it is
The three standard capital-appraisal measures. Net present value discounts a project's future cash flows to today and subtracts the investment; internal rate of return is the discount rate at which that value is zero; payback is simply how long the outlay takes to recover
NPV answers how much value is created, IRR answers at what rate, payback answers how long the capital is exposed
Impact on industries
- NPV is the theoretically correct measure, since it states value created in currency rather than as a rate that ignores project size
- IRR flatters small, fast projects over large value-creating ones, and can produce multiple or meaningless answers where cash flows change sign
- Payback ignores everything after the recovery point, so it rejects long-lived infrastructure that creates most of its value late
- All three are only as good as the cash flow forecast and the discount rate, both of which are assumptions rather than facts