Please explain how " A project’s IRR can be positive even if the NPV is negative "
If the required rate of return is greater than the IRR, then the NPV will be negative.
Example:
Initial investment: $100,000.
Cash flow in one year: $105,000.
WACC: 7%.
IRR = 5%, NPV = -$1,869.
Another way to understand this:
When the NPV of the project is zero, then the discount rate (the wacc in most cases) is equal to the IRR of that specific project.
If the IRR of a project is higher than the WACC, you are gaining an extra revenue from the project, which is that positive NPV. Remember that NPV = 0 doesn’t mean you winning nothing, in fact you are earning WACC% interest every year, assuming of course all the cash flows are reinvested on the project (in real state projects this assumption holds for example).
If IRR of the project is lower than the WACC, the effect is contrary, you have negative NPV and you are already lossing money, because that project gives you an IRR% lower than your weighted average cost of capital (wacc).
GL
Thanks a lot
My pleasure.
I know this query has been resolved, but isn’t IRR for any project ALWAYS positive? Haven’t ever come across a negative IRR… So even if the NPV is negative, IRR WILL be positive nevertheless…
Year 0 cash outflow of $100
Year 1 cash inflow of $90
end of project
this is an example of a negative IRR
Interesting… Not quite practically possible though unless in a deflationary environment?
It’s practically possible. Hypothetical example: you are examining an advertising campaign for a product. It’s will costs $100 million this year, and will result in $30 million in cash inflows each year for the next three years.
in this case you would not launch the advertising campaign.
Nice question. For a project to have a negative IRR, the sum of its undiscounted cash flows must be lower than the initial investment.
IRR is basically not a benchmarked return. NPV is compared with benchmaked return.
Further to simply this, NPV discounts with the some rate of return and IRR is an inquiry on what is rate of return.
Thanks
Can someone help me understand how to calculate IRR or NPV? Is this something that I can do on a pen and paper? It sounds like this may be too complex of a calculation for pen and paper.
We are solving for IRR, or discount rate and any time solving for rate, I know that can be a difficult. Plus when solving for multiple cash flows, that must be time consuming.
There are buttons on your calculator to calculate NPV and IRR.
Thanks S200magician, yes, I have since learned how to do this on my financial calculator. Thanks for the pointer.
I guess there are other resources and NPV calculators like this one to and this oneto help make it easier to calculate. Thanks,
You’re welcome.