When risk analysis deals with costs and benefits that vary by year, which computations should be used?

• A. NPV
• B. IRR
• C. Either NPV or IRR
• D. Neither NPV nor IRR

Answer: (C)

When costs and benefits change year to year, you need a way to value those time-varying cash flows. Both net present value and internal rate of return do this by incorporating the time value of money.

Net present value sums each year’s cash flow discounted back to today using a rate that reflects risk. This makes it straightforward to see the overall value of a sequence of varying yearly amounts and to compare projects with different cash-flow patterns.

Internal rate of return derives from the same yearly cash flows but expresses the result as the rate of return that makes the total net present value zero. It’s a familiar, intuitive measure for comparing to a required return or hurdle rate.

Because both methods work with year-by-year cash flows and can incorporate risk via the discount rate or scenario analysis, either can be appropriate depending on how you want to present the results. Hence, the correct choice is that either method can be used.