Investment decision metrics: NPV vs IRR vs payback vs PI

What each metric is optimizing

• NPV: value created in dollars at a chosen required return.
• IRR: implied return rate (can be undefined or misleading for some cash flows).
• Payback: how quickly you get cash back (often used as a risk constraint).
• Profitability index (PI): value per dollar invested (useful when capital is constrained).

Common traps

• Using IRR for mutually exclusive projects of different scale (NPV is better).
• Ignoring time value by using simple payback only.
• Using a single discount rate without scenario analysis.

Practical decision flow

• Start with NPV at your MARR.
• Use payback as a constraint if runway/risk matters.
• Use IRR for intuition and comparison, but validate with NPV.
• Use PI when you have limited capital and many opportunities.