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Importance of IRR and NPV in capital budgeting/planning

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What is capital planning? Why is the internal rate of return important to an organization? Why is net present value important to a project? How would you select from multiple projects presented to your organization?

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Solution Summary

This question addresses the importance of the internal rate of return (IRR) and net present value (NPV) to an organization in the capital planning/budgeting process. It also asks for an explanation of how these decision criteria are used to select which projects an organization should accept when presented with multiple opportunities.

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Capital Planning is the evaluating of long-term investments. This includes deciding which projects to pursue, projecting the costs versus benefits of various investment options, and deciding how to raise the money required to invest in the long-term investment or project.

The internal rate of return (IRR) is the rate of return whereby the present value of all future cash flows arising from the project or investment are equal to the initial amoung of money invested or the initial cost of the investment or project. The IRR is used to evaluate decisions about whether to accept or reject different investment or projects. Also, because the IRR is a rate of return on an investment, ...

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