The Financial Times Guide to Understanding Finance, 2nd Edition

21

NPV and IRR

• Basic principles
• Present value
• Net present value
• The internal rate of return
• Applying NPV and IRR
• Problems of the IRR approach
• The big picture
• Excel section

I know, you do know and may even use frequently the concepts of NPV and IRR. But these two essential tools, as well as a few related ideas, are the backbone of many calculations in finance and just too important not to discuss in any desktop companion. There are some things worth reviewing and refreshing, and that’s exactly what we’ll do in this chapter.

Basic principles

Let’s start with three questions whose answers will lead us to three basic principles or ideas implicitly built into many financial tools. First question: Would you rather have $100 today or next year? ...