NPV: The NPV (Net Present Value) method of investment appraisal is to accept projects with a positive NPV.NPV is the value obtained by discounting all cash outflows and inflows of a capital investment project by a chosen target rate of return or cost of capital (here it is the weighted average cost of capital i.e. WACC). Even though the NPV method is technically superior to IRR and simpler to calculate, but it still has its drawbacks. It is lengthier and harder to calculate than Return on Capital Employed (ROCE) or payback period methods. This is a major drawback of NPV, and non-accountants or people with just basic understanding of accounts and finance find it hard to arrive at a final and accurate figure for NPV. Its calculation involves finding an accurate discount rate. A slight change of even 1% or 2% in the discount rate can distort the results to a great extent.
IRR: The Internal Rate of Return (IRR) method of investment appraisal is to accept those projects whose IRR (the rate at which the NPV is zero) exceeds a target rate of return.
This is mostly useful when cash flows are conventional (i.e. first negative cash flows, then a stream of positive cash flows). If in some years cash flow is positive, then negative, and then positive again; there may arise different results from the IRR method. Moreover, it considers the time value of money and all of a project’s cash flows.
On the other hand it doesn’t take into account the sensitivity of change of any variable in the project. IRR completely ignores the relative sizes of investments.
Discounted Payback Period: Discounted Payback Period (expressed in years) is the time it takes the cash inflows discounted at an appropriate cost of capital from a capital investment project to equal the cash outflows.