FINACIAL MODELLING WITH EXCEL
PRACTICAL ASSIGNMENT
Topic – Net Present Value (NPV) & Internal Rate
of Return (IRR)
Name – Parth Mishra
Roll No. – 223585
College Roll No. – 22073503124
Course – [Link]. Program
Section – B
Year – 3rd
Net Present Value (NPV) and Internal Rate of Return (IRR)
are two key financial modelling methods for determining the
profitability and viability of investment projects. NPV
calculates the absolute value of an investment's cash flows
discounted to the present, whereas IRR determines the
discount rate at which these cash flows break even. Both
metrics are critical in decision-making, allowing organizations
to assess project viability, compare alternative investments,
and allocate resources efficiently.
In Excel, their calculation is simple and provides useful
information about financial performance. This project
investigates the concepts of net present value and internal
rate of return, as well as their differences and applications in
Excel.
Net Present Value (NPV)
Definition - The difference between the present value of cash
inflows and the present value of cash outflows over a period of
time. NPV calculates the current value of future payments using
an appropriate discount rate.
Formula –
Cash Flow
NPV = ∑ ( ¿¿ ) – Initial Investment
where:
Cash Flow = Cash flow at time
r = Discount rate
t = Time period
Importance –
Measures the profitability of an investment in absolute
terms.
Indicates whether a project adds value to the company.
Accounting for the time value of money.
Internal Rate of Return (IRR)
Definition - IRR is a key financial metric that estimates the
profitability of investments or projects. It is the discount rate that
makes the NPV of all cash flows equal to zero.
Formula –
Cash Flow
0=∑( ¿¿ ) – Initial Investment
where:
Cash Flow = Cash flow at time
IRR = Internal Rate of Return
t = Time period
Importance –
Provides the rate of return on investment.
Helps in comparing projects with varying cash flows.
Make informed investment decisions based on a
standardized metric.
Calculation of NPV and IRR in Excel -
a. NPV Calculation:
1. Identify cash flows and the discount rate.
2. Use the formula:
=NPV(discount_rate, range_of_cash_flows).
3. Subtract the initial investment from the result.
b. IRR Calculation:
1. Identify cash flows (include the initial investment
as a negative value).
2. Use the formula:
=IRR(range_of_cash_flows).
Difference Between NPV and IRR
BASIC NPV IRR
Objective Aims to maximise Seeks to find the rate
investment value by where cash inflows
comparing cash and outflows are
inflows and outflows. equal.
Approach Uses an absolute Uses a relative
approach to calculate approach to calculate
the present value of the rate of return.
expected cash flows
Cash Flows Considers all cash Assumes a single
flows throughout the initial investment
project's duration. followed by a series
of cash inflows.
Reinvestmen Assumes that cash Assumes that cash
t Assumption inflows are inflows are
reinvested at the reinvested at the IRR
discount rate. itself.
Decision Accept projects with Accept projects
Criteria a positive NPV. where IRR exceeds
the cost of capital.
Multiple NPV can handle IRR may struggle
Rates projects with with projects having
different discount multiple rates of
rates. return.
Sensitivity Sensitive to changes Sensitive to changes
in cash flows in the discount rate
affecting the present used for calculations.
value.
Relation between IRR, NPV and Cost of Capital
Case Study
Solar Power Plant Expansion
Tata Power considered expanding its renewable energy
portfolio by adding a 50 MW solar power plant. The
estimated cost was ₹350 crores, with projected annual
cash inflows of ₹60 crores for 25 years. Find out the
NPV and IRR. Also decide if the company should
consider this decision or not.
Financial Analysis -
1. NPV Calculation:
o Discount rate: 10% (based on weighted
average cost of capital).
o NPV = Sum of discounted cash flows (₹60
crores/year) – Initial Investment (₹350 crores).
o The calculated NPV was ₹120 crores,
indicating that the project added value.
2. IRR Analysis:
o The IRR was calculated as 14%, higher than
the discount rate, showing profitability.
Decision -
Since the NPV was positive and the IRR exceeded the
cost of capital, Tata Power approved the project,
reinforcing its focus on sustainable growth while
ensuring financial viability.
Conclusion –
After learning the NPV vs IRR distinctions, it is clear
that both are crucial for evaluating investment
opportunities. NPV assesses the absolute value by
discounting future cash flows, while IRR calculates the
rate of return to match inflows with outflows.
