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IRR is the rate at which npv is zero so why we bother to use as it is clear that its a breakeven point at which we gain nothing from project.
we need the NPV when irr is zero so that we can base it on as our decision criteria.Remember also that irr as a method has some advantages when making some investment decisions.
Just suppose the cost of capital is 10%, and that the NPV of a project at 10% is +5,000.
Clearly we should accept the project because the NPV is positive.
However, in real life it is impossible to calculate the cost of capital for a company precisely (the cost of capital chapters later in the Course Notes explain why). So although we may think it is 10%, it might turn out to be 11% or 12% or whatever.
The NPV is positive at 10%, but it might be negative at 11% or 12% or whatever, so by accepting the project there is always a risk that we have made a bad decision.
If we calculate the IRR of the project and get (say) 12%, then it means that if we have estimated the cost of capital wrongly then at least we are still OK doing the project provided that the cost of capital does not go above 12% (because the NPV would still be positive).
It gives an indication of the risk. If the IRR was 10.2% we would be very worried about taking the risk because just a small error in the cost of capital would mean that the project turned out not to be good. On the other hand, if the IRR turned out to be 16% then we would be much less worried because the chance of our estimate of cost of capital being wrong by that much would be very small.
Thankyou so much. I always knew that irr is the rate at which NPV is zero but never had the idea why we assumed it.
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