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Capital Planning


What is capital planning? Why is IRR, Internal Rate of Return, important to an organization?

IRR, Internal Rate of Return, helps companies figure out what the rate of return is on individual projects; what the project earns. This is important to companies as it  helps gauge which projects to accept or reject. To accept a project, the IRR is equal to or greater than or equal to the required rate of return. If the IRR is less than the required rate of return, then it is rejected. IRR is important to organizations as it’s typically in line with the goal of maximizing shareholder wealth.

Why is NPV important to a project? How do you select from multiple projects presented to an organization?

The NPV is the Net Present Value. NPV can be defined as “A capital-budgeting decision criterion defined as the present value of the free cash flows after tax less the project’s initial outlay.” This gives an indication of the net value, by terms of today’s dollar value, of an investment proposal. This is another method to help companies make the decision to accept or reject a project. If the projects net value is greater than or equal to zero, the project is accepted. When it is less than zero, this determines rejection of that project.

Depending on the scope of the projects and organization, I would recommend either one of these methods to review the eligibility of projects. However, I would prefer the IRR as percentages are often easier to understand and apply. However, I wouldn’t rule out NPV, and would use it as an alternate means to decide if the IRR didn’t seem stable or sensible for the given project scopes.  

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