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    NPV Irr

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    Juan Antonio
    This document discusses rules for evaluating capital budgeting projects using net present value (NPV) and internal rate of return (IRR). It states that projects should be accepted if their NPV is positive or their IRR exceeds the cost of capital. It provides examples calculating NPV and IRR for various projects and discusses how non-standard projects may have multiple IRRs. It also covers evaluating mutually exclusive projects and valuing projects on an incremental basis.

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    Attribution Non-Commercial (BY-NC)
    Download as XLS, PDF, TXT or read online from Scribd

    NPV Irr

    Uploaded by

    Juan Antonio
    45 views6 pages
    This document discusses rules for evaluating capital budgeting projects using net present value (NPV) and internal rate of return (IRR). It states that projects should be accepted if their NPV is positive or their IRR exceeds the cost of capital. It provides examples calculating NPV and IRR for various projects and discusses how non-standard projects may have multiple IRRs. It also covers evaluating mutually exclusive projects and valuing projects on an incremental basis.

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    Net present value vs. internal rate of return

    Original Title

    npv_irr

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    © Attribution Non-Commercial (BY-NC)

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    This document discusses rules for evaluating capital budgeting projects using net present value (NPV) and internal rate of return (IRR). It states that projects should be accepted if their NPV is positive or their IRR exceeds the cost of capital. It provides examples calculating NPV and IRR for various projects and discusses how non-standard projects may have multiple IRRs. It also covers evaluating mutually exclusive projects and valuing projects on an incremental basis.

    Copyright:

    Attribution Non-Commercial (BY-NC)
    Download as XLS, PDF, TXT or read online from Scribd
    Download as xls, pdf, or txt
    45 views6 pages

    NPV Irr

    Uploaded by

    Juan Antonio
    This document discusses rules for evaluating capital budgeting projects using net present value (NPV) and internal rate of return (IRR). It states that projects should be accepted if their NPV is positive or their IRR exceeds the cost of capital. It provides examples calculating NPV and IRR for various projects and discusses how non-standard projects may have multiple IRRs. It also covers evaluating mutually exclusive projects and valuing projects on an incremental basis.

    Copyright:

    Attribution Non-Commercial (BY-NC)
    Download as XLS, PDF, TXT or read online from Scribd
    Download as xls, pdf, or txt
    of 6

    NPV AND IRR RULES

    1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22

    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 1 200 91% 182 (418) 2 200 83% 165 (253) 3 500 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 1 2 3 4 5 6 7 8 9 10
    IRR RULE

    For a standard project, IRR Rule:

    NPV > 0

    if and only if if and only if

    IRR > Cost of Capital IRR > Cost of Capital

    Choose a project

    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

    1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20

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

    Cost of capital

    12%

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

    0 (400,000) 100% (400,000) (400,000) 1,148 10%

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

    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

    A B 1 Year 0 2 Net cash flow (400,000) 3 4 Discount Rate NPV 5 6 2% (8,612) 7 4% (5,769) 8 6% (3,418) 9 8% (1,509) 10 10% 11 12% 1,148 12 14% 1,970 13 16% 2,497 14 18% 2,758 15 20% 2,778 16 22% 2,580 17 24% 2,185 18 26% 1,612 19 28% 879 20 30% 21 32% (1,010) 22 34% (2,139) 23 36% (3,374) 24 38% (4,705) 25 40% (6,122)

    D 1 2 960,000 (572,000)

    4,000 2,000 Net Present Value 0% (2,000) (4,000) (6,000) (8,000) (10,000) Discount Rate 20% 40% 60%

    Page 4

    NPV AND IRR RULES

    1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19

    A B C D AN EXAMPLE OF MUTUALLY EXCLUSIVE PROJECTS Cost of capital 10% Year Project A Cash flow PV factor PV of cash flow NPV IRR Cash flow PV factor PV of cash flow NPV IRR 0 (10,000) 100% (10,000) 8,182 100% (20,000) 100% (20,000) 11,818 75%

    1 20,000 91% 18,182

    Project B

    35,000 91% 31,818

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

    Page 5

    NPV AND IRR RULES

    1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18

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

    Cost of capital

    10% Year 0 (10,000) 100% (10,000) 8,182 (10,000) 100% (10,000) 3,636 1 20,000 91% 18,182

    Project A

    Cash flow PV factor PV of cash flow NPV Cash flow PV factor PV of cash flow NPV

    Project B-A

    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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