The Net Present Value (NPV) profile plots the net present value of a project at different level of cost of capital. From the NPV profile, we can see a relationship between NPV and the internal rate of return (IRR) of the project.
We know that when the IRR of the project is equivalent to the cost of capital, the return generated by the project will be completely offset by the cost of undertaking that project. As a result, the NPV of the project will be zero. We can determine the IRR of a project by looking at where the NPV profile crosses the horizontal (i.e. cost of capital) axis. The chart below shows the NPV profile of a project. You can see how the shape of the NPV changes as you change some of the cash flows of the project. Challenge: Can you come up with a cash flow stream that will give you at least two IRRs (i.e. a NPV profile that intersects the horizontal axis at least twice)? |