NPV · IRR · Investment Feasibility
Net Present Value & Internal Rate of Return
What is NPV?
- Judged by converting future cash into present value
- NPV > 0 means the investment is worthwhile
- IRR is intuitive, but it can mislead when project sizes differ
The conversation in investment reviews changes. Instead of appeals like “the equipment is too old to keep running,” the discussion turns to how much after-tax cash a KRW 4.2 billion (≈ US$3,142,300) investment returns each year for 7 years, and what is left once that is converted back into today’s money. The biggest change is that the timing of cash inflows becomes a decision-making variable. Each year of delay in recovery reduces the value accordingly, so negotiation items such as shortening the construction period or payment terms suddenly carry financial weight.
Review materials usually carry four metrics together. NPV shows the dollar amount, IRR the rate, payback period the speed, and ROI the accounting profitability. The trouble starts when they disagree, and NPV breaks the tie. Compare a project that invests KRW 3 billion (≈ US$2,244,500) for an NPV of KRW 500 million (≈ US$374,100) with one that invests KRW 300 million (≈ US$224,500) for an IRR of 40%: the first is the one that actually adds more cash to the company’s coffers. When investment size or asset life differs, recalculate using incremental cash flow or convert to equivalent annual annuity (EAA) before comparing. Use WACC as the discount rate, but for projects with a different risk profile, such as overseas new ventures, add a separate risk premium.
How the cash-flow table is built matters more than the formula. Depreciation involves no cash outflow, so it isn’t deducted as an outflow, but the tax it saves is added as a tax shield. When inventory and receivables grow, the increase in working capital is booked as an outflow and recovered in the final year; salvage value and demolition costs must not be left out either. Then add a sensitivity check showing where NPV turns negative when the discount rate moves 1 percentage point, selling price 5%, or utilization 10 percentage points, and the review shifts from “does it work or not” to which assumptions must be defended.
The most common mistake is working backward: fixing the conclusion first and then fitting the numbers. The moment you double year-5 revenue or cut the discount rate from 8% to 6% to make NPV positive, the document stops being review material and becomes paperwork for sign-off. Counting sunk costs, such as adding design fees already spent to the investment, and ignoring cannibalization, where a new product takes volume from existing lines, are frequent errors too. Approving on IRR alone is risky as well. If the cash-flow signs change twice along the way, IRR yields two values or none at all, and because IRR assumes recovered cash is reinvested at the same rate, it gives an overstated figure.
Eunpyo HongExpert in company analysis, startups, and startup fundraising
Kwangdong MinExpert in business models, revenue models, and market researchRooted in Irving Fisher’s capital theory, it was standardized as a capital budgeting technique in corporate finance in the mid-20th century.
Consider a hypothetical case. Company A, a Korean auto-parts manufacturer (320 employees, KRW 110 billion (≈ US$82,298,400) in annual revenue), had spent two years unable to decide on replacing a 15-year-old press line. Production pushed for a KRW 4.2 billion (≈ US$3,142,300) new machine, Finance for a KRW 1.2 billion (≈ US$897,800) partial overhaul, and both sides just kept repeating “ours is right.” The management meeting gave them 8 weeks and told them to put both options in the same table.
- Manager Park of the production engineering team laid out the 7-year after-tax cash flows of both options on a single page. The new option showed annual inflows of KRW 980 (≈ US$1) million, driven by a defect rate falling from 3.2% to 0.8% and six fewer night-shift staff.
- The finance director set the rule: 'Take our WACC of 7.4%, add 1.5 percentage points for equipment localization risk, and use 8.9%.' Applying the same discount rate to both options put them on equal footing.
- In the first pass, the new option came out at an NPV of KRW 1.14 billion (≈ US$852,900) and an IRR of 18%, while the conservative option came out at an NPV of KRW 420 million (≈ US$314,200) and an IRR of 24%. On IRR alone the conservative option wins, but the new option leaves the company more than twice as much money.
- When the CFO asked, “What happens if the selling price drops?”, Manager Park opened the sensitivity table and answered that NPV turns negative if the price falls 6% or utilization drops below 72%.
- The management meeting approved the new option but set 78% utilization as a quarterly checkpoint metric. Fourteen months after launch, the defect rate was 0.9% and the actual IRR was 16.5%, 1.5 percentage points below plan but comfortably above the 8.9% required return.