Que es el van y el tir

Finance

When we face the challenge of making new investments, we need to know in advance the chances of success, profitability, the benefits it will bring and the viability of the project we intend to start. For this purpose, we rely on financial indicators. The NPV and IRR, (Net Present Value and Internal Rate of Return) respectively, are two financial indicators that allow us to analyze, in a safe way, the possible investment project and will help us to dissipate with precise information, those frequent doubts.

NPV and IRR are two concepts that, although very similar to each other, maintain differences that identify them and at the same time complement them to fulfill their function. This function consists of determining the benefit and profitability that any new project will bring us, once the investment has been made. With the analysis of parameters such as cash flow and terms of time, these two indicators will give us an important vision of the possibilities of success of the new project.

Negative npv

Two widely used parameters when calculating the viability of a project are the NPV (Net Present Value) and the IRR (Internal Rate of Return). Both concepts are based on the same thing, which is the estimation of the company’s cash flows (simplified, income minus net expenses).

Another way of calculating the same is to look at the Internal Rate of Return, which would be the interest rate at which the NPV becomes zero. If the IRR is high, we are looking at a profitable business project, which implies a return on investment comparable to high interest rates that may not be found in the market. However, if the IRR is low, it may be possible to find a better use for the money.

Of course, in the evaluation of a business project there are many other things to take into account, such as the time it takes to recover the investment, the risk of the project, cost-benefit analysis… and there are some problems such as the plausibility of cash flow predictions. But NPV and IRR are still an interesting starting point.

Van vs tir

We can define NPV as the present value of cash flows, net of investments.  It provides a measure of the profitability of the project analyzed in absolute value, i.e. it expresses the difference between the present value of the monetary units collected and paid. In turn, it will indicate the increase in the value of the company due to the project.

In this equation we can see how, while at the time of calculating the NPV the interest rate was known, in this case the unknown is the interest rate itself. Once the IRR has been calculated, we compare it with the interest rate used in the NPV calculation:

If the NPV of a project is positive, the IRR will be higher than the interest rate, and vice versa. The explanation lies in the fact that we have defined the IRR as the maximum cost of capital that a project can bear. If the interest rate used to discount the cash flows when calculating the NPV is lower than the IRR, it would therefore be lower than the maximum cost of capital supported and, therefore, the project will be profitable and the NPV will be positive and the IRR higher than the interest rate.

Van and tir in english

The NPV and IRR are two types of very powerful financial tools in the world of finance and give us the possibility to evaluate the profitability that different investment projects can give us. In many cases, the investment in a project is not given as an investment but as the possibility of starting up another business due to the profitability.

The NPV or Net Present Value, this financial tool is known as the difference between the money that enters the company and the amount that is invested in the same product to see if it is really a product (or project) that can give benefits to the company.

The NPV has an interest rate that is called the cut-off rate and is used to be constantly updated. This cut-off rate is given by the person who is going to evaluate the project and that is done together with the people who are going to invest.

By means of the NPV it is possible to know if a project is viable or not before starting to carry it out and also, within the options of the same project, it allows us to know which is the most profitable of all or which is the most convenient option for us. It also helps us a lot in the purchase processes, since in case we want to sell, this option helps us a lot to know what is the real amount of money in which we have to sell our company or if we earn more staying with our business.