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Why are NPV and IRR considered equivalent in this particular scenario?

In situations where the cash flows from an investment are conventional (initial outflow followed by a series of inflows), the IRR will yield a rate that makes the NPV equal to zero.

This is because the IRR represents the discount rate at which the present value of future cash flows equals the initial investment, which aligns with the NPV approach of evaluating the desirability of a project.

When cash flows remain constant or change uniformly, NPV and IRR tend to give consistent investment decisions because they both derive from the same premise of valuing future cash inflows against the cost of the initial outlay.

The reason NPV and IRR are equivalent in this case is that when the project's cash flows are reinvested at the IRR rate, they yield returns equivalent to the NPV calculation.

This reinvestment rate assumption is a key factor in the equivalence between NPV and IRR, as it ensures the cash flows are treated the same way in both metrics.

The relationship between NPV and IRR breaks down when the project has non-conventional cash flows, multiple IRRs, or differing reinvestment rate assumptions, which can lead to contradictory investment decisions.

The equivalence between NPV and IRR is a result of the fundamental relationship between the two metrics, where the IRR represents the discount rate that makes the NPV equal to zero.

This equivalence holds true only when the cash flow pattern is conventional and the reinvestment rate assumption is the same for both NPV and IRR calculations.

The simplicity and intuitive nature of NPV, which directly measures the net contribution of a project, can make it a more preferred metric than IRR in certain decision-making scenarios.

In practice, financial analysts often use both NPV and IRR as complementary tools to gain a comprehensive understanding of a project's profitability and risk profile.

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