When IRR results contradict NPV, which measure should be preferred?

• A. IRR
• B. A blend of both
• C. The internal rate of return
• D. NPV, because it directly relates to wealth of the business

Answer: (D)

The key idea is choosing the measure that best reflects how a project changes the firm’s wealth. Net present value does this directly by translating all future cash flows into today’s currency using the cost of capital, then comparing them to the initial outlay. In other words, NPV tells you exactly how much value a project adds (or destroys) for the owners.

IRR, while useful as a rate of return, has pitfalls that can mislead when compared with NPV. It assumes reinvestment of intermediate cash flows at the project’s own IRR, which is often unrealistic. It can also produce multiple IRRs for non-traditional cash flows or give high ranking to projects with small scale but high percentage returns, even if they add little value overall. These issues mean IRR can suggest a favorable decision when the actual wealth created (as measured by NPV) is disappointing or negative.

Because NPV directly measures wealth addition and is consistent with maximizing shareholder value across different project sizes and timing, it should be preferred when the two measures give conflicting signals.