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    NPV Irr

    Uploaded by

    Cloude HolLowen
    1) The document discusses rules for evaluating capital budgeting projects using net present value (NPV) and internal rate of return (IRR). 2) The NPV rule states that projects with a positive NPV should be accepted, while the IRR rule indicates projects with an IRR higher than the cost of capital should be accepted. 3) However, some projects may have multiple IRRs, so the NPV rule is more reliable for determining if a project should be accepted.

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    Download as XLS, PDF, TXT or read online from Scribd

    NPV Irr

    Uploaded by

    Cloude HolLowen
    14 views6 pages
    1) The document discusses rules for evaluating capital budgeting projects using net present value (NPV) and internal rate of return (IRR). 2) The NPV rule states that projects with a positive NPV should be accepted, while the IRR rule indicates projects with an IRR higher than the cost of capital should be accepted. 3) However, some projects may have multiple IRRs, so the NPV rule is more reliable for determining if a project should be accepted.

    Original Description:

    Economy

    Original Title

    npv_irr

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    1) The document discusses rules for evaluating capital budgeting projects using net present value (NPV) and internal rate of return (IRR). 2) The NPV rule states that projects with a positive NPV should be accepted, while the IRR rule indicates projects with an IRR higher than the cost of capital should be accepted. 3) However, some projects may have multiple IRRs, so the NPV rule is more reliable for determining if a project should be accepted.

    Copyright:

    © All Rights Reserved
    Download as XLS, PDF, TXT or read online from Scribd
    Download as xls, pdf, or txt
    14 views6 pages

    NPV Irr

    Uploaded by

    Cloude HolLowen
    1) The document discusses rules for evaluating capital budgeting projects using net present value (NPV) and internal rate of return (IRR). 2) The NPV rule states that projects with a positive NPV should be accepted, while the IRR rule indicates projects with an IRR higher than the cost of capital should be accepted. 3) However, some projects may have multiple IRRs, so the NPV rule is more reliable for determining if a project should be accepted.

    Copyright:

    © All Rights Reserved
    Download as XLS, PDF, TXT or read online from Scribd
    Download as xls, pdf, or txt
    of 6

    NPV AND IRR RULES

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    A
    B
    C
    NPV RULE FOR CAPITAL BUDGETING

    Choose a project if it costs less than the PV of its cash flows. More generally:
    take a project if its Net Present Value is positive.
    EXAMPLE
    Interest rate
    Year
    Cash flow
    PV factor
    PV of cash flow
    Cumulative PV
    Net Present Value

    10%
    0

    (600)
    100%
    (600)
    (600)
    123

    200
    91%
    182
    (418)

    200
    83%
    165
    (253)

    500
    75%
    376
    123

    Investors would have to invest 123 more (a total of 723) to get the cash flows of 200, 200,
    and 500 at an interest rate of 10%. Therefore the project has a value of 123 for investors.
    The interest rate is called the cost of capital, because it is the opportunity cost of funds - the
    rate investors can earn on alternative investments.

    Page 1

    NPV AND IRR RULES

    A
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    8
    9
    10

    IRR RULE

    For a standard project,


    IRR Rule:

    NPV > 0

    Choose a project

    if and only if

    IRR > Cost of Capital

    if and only if

    IRR > Cost of Capital

    Standard means
    - cash outflows occur in early years and cash inflows in later years.
    - the alternative to the project is the status quo.

    Page 2

    NPV AND IRR RULES

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    A
    B
    C
    D
    E
    F
    G
    NONSTANDARD PROJECTS MAY HAVE MORE THAN ONE INTERNAL RATE OF RETURN

    Cost of capital

    Year
    Net cash flow
    PV factor
    PV of net cash flow
    Cumulative PV
    Net present value
    IRR (Internal Rate of Return)

    12%

    0
    (400,000)
    100%
    (400,000)
    (400,000)
    1,148

    960,000 (572,000)
    89%
    80%
    857,143 (455,995)
    457,143
    1,148

    10%

    For this project, varying the initial guess in the IRR function can cause the IRR to change.
    This is a good project (positive NPV), but you can't tell it from the IRR function. The following
    chart shows that there are two break-even costs of capital or IRR's. The NPV is positive at the
    actual cost of capital (12%), so it is a good project.

    Page 3

    NPV AND IRR RULES

    0
    (400,000)

    Discount Rate

    NPV

    2%
    4%
    6%
    8%
    10%
    12%
    14%
    16%
    18%
    20%
    22%
    24%
    26%
    28%
    30%
    32%
    34%
    36%
    38%
    40%

    (8,612)
    (5,769)
    (3,418)
    (1,509)
    1,148
    1,970
    2,497
    2,758
    2,778
    2,580
    2,185
    1,612
    879
    (1,010)
    (2,139)
    (3,374)
    (4,705)
    (6,122)

    D
    1
    2
    960,000 (572,000)

    4,000
    2,000
    -

    Ne t Pre se nt Value

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    A
    Year
    Net cash flow

    0% 5% 10% 15% 20% 25% 30% 35% 40% 45%


    (2,000)
    (4,000)
    (6,000)
    (8,000)
    (10,000)
    Discount Rate

    Page 4

    NPV AND IRR RULES

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    A
    B
    C
    D
    E
    AN EXAMPLE OF MUTUALLY EXCLUSIVE PROJECTS
    Cost of capital

    10%
    Year

    Project A

    Cash flow
    PV factor
    PV of cash flow
    NPV
    IRR

    (10,000)
    100%
    (10,000)
    8,182
    100%

    20,000
    91%
    18,182

    Project B

    Cash flow
    PV factor
    PV of cash flow
    NPV
    IRR

    (20,000)
    100%
    (20,000)
    11,818
    75%

    35,000
    91%
    31,818

    Project B is best, even though its IRR is lower.

    Page 5

    NPV AND IRR RULES

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    A
    B
    C
    D
    E
    PROJECTS CAN BE VALUED ON AN INCREMENTAL BASIS

    Cost of capital

    10%
    Year

    Project A

    Cash flow
    PV factor
    PV of cash flow
    NPV

    (10,000)
    100%
    (10,000)
    8,182

    20,000
    91%
    18,182

    Project B-A

    Cash flow
    PV factor
    PV of cash flow
    NPV

    (10,000)
    100%
    (10,000)
    3,636

    15,000
    91%
    13,636

    Project B has a positive NPV relative to A (on an incremental basis) so should be taken.

    Page 6

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