NPV and WACC

Net present value(NPV) is defined as the present value of future net cash flows discounted at the cost of capital, minus the cost of the investment. Internal rate of return (IRR) is defined as the interest rate that equates the present value of future returns to the investment outlay. The IRR method, like the NPV method, meets the objection to the payback approach. However, under certain circumstances conflicts may arise. Such conflicts are caused by the fact that the NPV and IRR methods make different assumptions about the rate at which cash flows may be reinvested, or the opportunity cost of cash flows. In general the assumption of the NPV method that reinvestment will be at the cost of capital is the correct one. Accordingly, our preference is for using the NPV method to make capital budgeting decisions.