In capital budgeting, why NPV is preferred over IRR??

NPV method is not superior over IRR & vice versa. The method to be applied depends upon the project. I f the CF is not even over the project period NPV is the best method. If CFs are even then IRR is best as it gives return in % terms which is easier to understand.

I found a good article about this issue a several years ago. I leave the URL for your consideration

 URL:http://www.investopedia.com/ask/answers/05/irrvsnpvcapitalbudgeting.asp

The "IRR" is a discount rate that cancels the "NPV" of a series of financial flows.

The IRR is a decision tool for investment. An investment project will generally applied only if its expected IRR is sufficiently higher than the bank rate, to take particular account of the premium specific to the type of project risk.

Mathematically, if the IRR is higher than the discount rate of capital (cost of capital), the NPV of the project is positive.

Let us remember that the NPV is the reference criterion for comparing projects, the IRR is not a relevant criterion for project selection, it just helps to know if the projects are profitable (comparison between the IRR of each project and discount rate of capital).

As Well, let's consider the case of a company can choose between two different projects requiring an investment of the same amount. Consider its discount rate is10%:

                                                    Project A :                                      Project B :

Investment (Year1) :                      20                                                     20

Incomes :

Year2 :                                            0                                                  20

Year3 :                                          30                                                   6

The analysis of these two projects provides:

Project A :                                                           

IRR :              [0=20-(30((1+R)^-2))]     R=22 %              

NPV :                               [30(1.1^-2)] -20 =  4.8                             

Project B :

IRR :        [0=20- (6(1+R)^-2) + (20(1+R)^-1)]    R= 24 %

NPV :       [6(1.1^(-2)) +20(1.1^(-1))] -20  =  3.1

The improper use of IRR(choice of project B has the highest IRR ) implies an updated income of3.1 is less than project Areports (NPV4.8).

The IRR provides information on the rate of return on investment, but it does not take into account certain parameters and that is that in some cases alowest project IRR is sometimes preferable to another project that has a higher IRR.

In conclusion, the use of IRR may influence very differently investment decisions, since it implicitly assumes that the amount of net cash flows throughout the duration of the project can be reinvested at the same rate of return internal. The advantage of IRR is that it is an intrinsic indicator of a project, instead of the NPV calculation which depends on the discount rate.