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    NPV Irr

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    danielmugabo
    This document discusses rules for evaluating capital budgeting projects using net present value (NPV) and internal rate of return (IRR). It provides examples of how to calculate NPV and IRR for projects and explains that the project with the highest NPV or IRR above the cost of capital should be selected. However, it notes that non-standard projects may have multiple IRRs and the IRR rule alone cannot determine if a project should be accepted.

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    NPV Irr

    Uploaded by

    danielmugabo
    21 views6 pages
    This document discusses rules for evaluating capital budgeting projects using net present value (NPV) and internal rate of return (IRR). It provides examples of how to calculate NPV and IRR for projects and explains that the project with the highest NPV or IRR above the cost of capital should be selected. However, it notes that non-standard projects may have multiple IRRs and the IRR rule alone cannot determine if a project should be accepted.

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    npv_irr

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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 provides examples of how to calculate NPV and IRR for projects and explains that the project with the highest NPV or IRR above the cost of capital should be selected. However, it notes that non-standard projects may have multiple IRRs and the IRR rule alone cannot determine 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
    21 views6 pages

    NPV Irr

    Uploaded by

    danielmugabo
    This document discusses rules for evaluating capital budgeting projects using net present value (NPV) and internal rate of return (IRR). It provides examples of how to calculate NPV and IRR for projects and explains that the project with the highest NPV or IRR above the cost of capital should be selected. However, it notes that non-standard projects may have multiple IRRs and the IRR rule alone cannot determine 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

    A B C D E F G H I
    1 NPV RULE FOR CAPITAL BUDGETING
    2
    3
    4 Choose a project if it costs less than the PV of its cash flows. More generally:
    5 take a project if its Net Present Value is positive.
    6
    7 EXAMPLE
    8
    9 Interest rate 10%
    10
    11 Year 0 1 2 3
    12
    13 Cash flow (600) 200 200 500
    14 PV factor 100% 91% 83% 75%
    15 PV of cash flow (600) 182 165 376
    16 Cumulative PV (600) (418) (253) 123
    17 Net Present Value 123
    18
    19 Investors would have to invest 123 more (a total of 723) to get the cash flows of 200, 200,
    20 and 500 at an interest rate of 10%. Therefore the project has a value of 123 for investors.
    21 The interest rate is called the cost of capital, because it is the opportunity cost of funds - the
    22 rate investors can earn on alternative investments.

    Page 1
    NPV AND IRR RULES

    A B C D E F G
    1 IRR RULE
    2
    3
    4 For a standard project, NPV > 0 if and only if IRR > Cost of Capital
    5
    6 IRR Rule: Choose a project if and only if IRR > Cost of Capital
    7
    8 Standard means
    9 - cash outflows occur in early years and cash inflows in later years.
    10 - the alternative to the project is the status quo.

    Page 2
    NPV AND IRR RULES

    A B C D E F G H
    1 NONSTANDARD PROJECTS MAY HAVE MORE THAN ONE INTERNAL RATE OF RETURN
    2
    3
    4 Cost of capital 12%
    5
    6
    7 Year 0 1 2
    8
    9 Net cash flow (400,000) 960,000 (572,000)
    10 PV factor 100% 89% 80%
    11 PV of net cash flow (400,000) 857,143 (455,995)
    12 Cumulative PV (400,000) 457,143 1,148
    13 Net present value 1,148
    14
    15 IRR (Internal Rate of Return) 10%
    16
    17 For this project, varying the initial guess in the IRR function can cause the IRR to change.
    18 This is a good project (positive NPV), but you can't tell it from the IRR function. The following
    19 chart shows that there are two break-even costs of capital or IRR's. The NPV is positive at the
    20 actual cost of capital (12%), so it is a good project.

    Page 3
    NPV AND IRR RULES

    A B C D E F G H
    1 Year 0 1 2
    2 Net cash flow (400,000) 960,000 (572,000)
    3
    4 Discount Rate NPV
    5
    6 2% (8,612)
    7 4% (5,769) 4,000
    8 6% (3,418)
    2,000
    9 8% (1,509)
    10 10% - -

    Net Present Value


    11 12% 1,148 0% 5% 10% 15% 20% 25% 30% 35% 40% 45%
    12 14% 1,970 (2,000)

    13 16% 2,497
    (4,000)
    14 18% 2,758
    15 20% 2,778 (6,000)
    16 22% 2,580
    (8,000)
    17 24% 2,185
    18 26% 1,612 (10,000)
    19 28% 879 Discount Rate
    20 30% -
    21 32% (1,010)
    22 34% (2,139)
    23 36% (3,374)
    24 38% (4,705)
    25 40% (6,122)

    Page 4
    NPV AND IRR RULES

    A B C D E
    1 AN EXAMPLE OF MUTUALLY EXCLUSIVE PROJECTS
    2
    3 Cost of capital 10%
    4
    5 Year 0 1
    6
    7 Project A Cash flow (10,000) 20,000
    8 PV factor 100% 91%
    9 PV of cash flow (10,000) 18,182
    10 NPV 8,182
    11 IRR 100%
    12
    13 Project B Cash flow (20,000) 35,000
    14 PV factor 100% 91%
    15 PV of cash flow (20,000) 31,818
    16 NPV 11,818
    17 IRR 75%
    18
    19 Project B is best, even though its IRR is lower.

    Page 5
    NPV AND IRR RULES

    A B C D E F G H
    1 PROJECTS CAN BE VALUED ON AN INCREMENTAL BASIS
    2
    3
    4 Cost of capital 10%
    5
    6 Year 0 1
    7
    8 Project A Cash flow (10,000) 20,000
    9 PV factor 100% 91%
    10 PV of cash flow (10,000) 18,182
    11 NPV 8,182
    12
    13 Project B-A Cash flow (10,000) 15,000
    14 PV factor 100% 91%
    15 PV of cash flow (10,000) 13,636
    16 NPV 3,636
    17
    18 Project B has a positive NPV relative to A (on an incremental basis) so should be taken.

    Page 6

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