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Should I use a combination of IRR, NPV and payback for capital budgeting?

I am wondering what method -- internal rate of return (IRR), net present value (NPV) or payback -- is the best method to use for capital budgeting purposes. Can you help?

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For capital budgeting, you'll want to examine the total investment in capital that is needed for the project – both initially, and over time.

For selecting the best project, you would use a combination of key financial indicators including IRR, NPV and payback to determine which project has the best risk versus reward. This is where net present value (NPV) can be used to gauge which project has the highest net benefit in today's dollar terms to the company, internal rate of return (IRR) can be used to gauge which project generates the greatest interest rate return, or payback period can be used to gauge which project generates a positive cash flow – where cumulative benefits exceed cumulative costs soonest (often a measure of risk).

This was first published in May 2007

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