Understand NPV, IRR and ROI before comparing investments

NPV, IRR and ROI answer different questions. NPV compares discounted value with initial outlay; IRR finds a break-even discount rate; ROI summarises relative profit without valuing timing. Choosing the largest percentage hides differences in scale, timing and risk. No metric replaces checking assumptions.

Hypothetical example, in EUR

EUR 1,000 invested returns EUR 600 at each of two year-ends. Simple ROI is 20%. At a 5% annual discount rate, NPV is about EUR 115.65 and annual IRR about 13.07%. These describe the same example but are not interchangeable. Positive NPV means exceeding the entered discount rate under those flows, not a guarantee they will occur.

−1 000 + 600 / 1.05 + 600 / 1.05² ≈ 115.65 EUR

What to check before deciding

Define monthly or annual flows and use a matching period discount rate. Do not replace available cash with accounting profit. Residual value is included once at the end. Repeated sign changes can create multiple IRRs; do not pick one to make the result attractive. Rates and flows are assumptions, not recommendations or guarantees.

What can change the result?

Timing, rate and signs of cash flows. Later payments can reverse early payback; the accumulated total alone does not assess risk.

Try the example and compare your own inputs

Reading the result

Positive NPV means the modelled flows exceed the selected discount rate. ROI ignores timing, while IRR may not be unique. Use the same time unit for the rate and cash flows.