Why is the net present value of a capital budgeting project equal to zero when its internal rate of return is used as the discount rate?
Calculating an NPV involves obtaining the present values of future cash flows. These future flows are greater than the project’s initial outflow–the IRR describes this difference. If the IRR is used as the discount rate in the NPV analysis, its effect is to exactly remove the greater value in the future cash flows. The present value of these flows becomes equal to the project’s initial outlay, and NPV calculates as equal to zero.
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