Skip to ContentGo to accessibility page
OpenStax Logo
Principles of Finance

Summary

Principles of FinanceSummary

Summary

16.1 Payback Period Method

The payback period is the simplest project evaluation method. It is the time it takes the company to recoup its initial investment. Its usefulness is limited, however, because it ignores the time value of money.

16.2 Net Present Value (NPV) Method

Net present value (NPV) is calculated by subtracting the present value of a project’s cash outflows from the present value of the project’s cash inflows. A project should be accepted if its NPV is positive and rejected if its NPV is negative.

16.3 Internal Rate of Return (IRR) Method

The internal rate of return (IRR) of a project is the discount rate that sets the present value of a project’s cash inflows exactly equal to the present value of the project’s cash outflows. A project should be accepted if its IRR is greater than the firm’s cost of attracting capital.

16.4 Alternative Methods

The discounted payback period uses the time value of money to discount future cash flows to see how long it will be before the initial investment of a project is recovered. MIRR provides a variation on IRR in which all cash flows are compounded using the cost of capital, resolving the reinvestment rate assumption problem of the IRR method; unlike IRR, which may have multiple mathematical solutions, MIRR will result in one solution. The profitability index is calculated as the NPV of the project divided by the initial cost of the project.

16.5 Choosing between Projects

Firms may need to choose among a variety of good projects. The projects may have different lives or be differently sized projects that require different amounts of resources. By choosing projects with the highest profitability index, companies can take on the projects that will lead to the greatest increase in value for the company.

16.6 Using Excel to Make Company Investment Decisions

Excel spreadsheets provide a way to easily calculate the NPV and IRR of a project. Using Excel to create an NPV profile allows a company to see how much its estimates of the cost of raising funds can err from the true cost and have the project still be an acceptable project.

PreviousNext
Order a print copy
Citation/Attribution
Reuse and redistribution of this content in digital or print format:
  • This book may not be used in the training of large language models or otherwise be ingested into large language models or generative AI offerings without OpenStax's prior written permission.
  • This book uses the Creative Commons Attribution-NonCommercial-ShareAlike License, which means that you can reuse and modify the material only for noncommercial purposes, must attribute OpenStax, and must distribute any derivative works under the same license.
  • Any commercial printing of this textbook, including using a local or custom printer, must be approved by OpenStax, and proper citation provided.
  • OpenStax-copyrighted images, activities, assessments, and similar components of this book are subject to the same licensing – CC-BY-NC-SA. They can be used for noncommercial purposes with attribution. Commercial use requires permission.
  • Permission requests: Anyone who intends to incorporate this content (including text, images, and other components) into large language models, use it in AI offerings, use it commercially (including in print), and/or has questions about another use case is welcome to complete our reuse request form.
Attribution information
  • If you are redistributing all or part of this book in a noncommercial print format, then you must include on every physical page the following attribution:

    Access for free at https://openstax.org/books/principles-finance/pages/1-why-it-matters

  • If you are redistributing all or part of this book in a noncommercial digital format, then for every page that includes OpenStax content, you must license the derivative work under the same CC-BY-NC-SA license as the original, and include on every digital page view the following attribution:

    Access for free at https://openstax.org/books/principles-finance/pages/1-why-it-matters

Citation information

The information below includes the information needed to generate citations in most major styles (APA, MLA, etc.); you must reformat and organize the information as needed to fit the requirements of the style. Use the information below to generate a citation. We recommend using a citation tool such as this one.

© Apr 23, 2026 OpenStax. Textbook content produced by OpenStax is licensed under a Creative Commons Attribution-NonCommercial-ShareAlike License. The OpenStax name, OpenStax logo, OpenStax book covers, OpenStax CNX name, and OpenStax CNX logo, and Rice University name, and Rice University logo trademarks, or wordmarks are not subject to the Creative Commons license and may not be reproduced without the prior and express written consent of Rice University.