In the video below, I explain this semester's assignment: how to build an Excel spreadsheet with all the data of your business in order to calculate and interpret its IRR and NPV.IRR and NPV in a nutshellNPV (net present value) is the sum of all the business's cash flows (the initial investment, which is negative, and the future inflows and outflows) brought to today's date at a minimum acceptable rate of return (in Brazil, TMA, taxa mínima de atratividade), which is the minimum return you require from the money. If the NPV is positive, the business earns more than that rate and creates value; if it is negative, you would be better off leaving the money in the alternative that earns the minimum rate.IRR (internal rate of return) is the rate that makes the NPV exactly zero. It is the project's own rate of return: if the IRR is higher than the minimum acceptable rate, the project is worth it; if it is lower, it is not.In Excel, the functions are NPV, which discounts the cash flows starting from the first period — which is why the investment made today is added outside the function — and IRR, which takes all the cash flows, including the initial investment.A business requires 1,000 reais today and returns 600 reais at the end of each of the next 2 years. With a minimum acceptable rate of return of 10% per year, what is the NPV and what does it indicate?Answer: NPV of 41.32 reais: it is worth it, because it earns more than 10% per year — NPV = −1,000 + 600 / 1.1 + 600 / 1.21 = −1,000 + 545.45 + 495.87 = 41.32. The 200 reais is the undiscounted sum, which ignores the time value of money.The spreadsheet shows that your business's IRR is 15% per year, and your minimum acceptable rate of return is 12% per year. What can you conclude?Answer: The NPV calculated at 12% is positive, and the business earns more than the minimum required — the IRR is the rate that makes the NPV zero; discounting at a rate below it (12% versus 15%), the NPV is positive. An IRR above the minimum rate and a positive NPV lead to the same decision in conventional projects.
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