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IRR and NPV

The document defines Net Present Value (NPV) and Internal Rate of Return (IRR) as methods for evaluating investments. It provides examples of calculating NPV and IRR for single payments, annuities, and cash flows that occur at irregular intervals or in groups. The examples are solved using a HP 10B II financial calculator to demonstrate the keystrokes needed.

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Rudini
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206 views21 pages

IRR and NPV

The document defines Net Present Value (NPV) and Internal Rate of Return (IRR) as methods for evaluating investments. It provides examples of calculating NPV and IRR for single payments, annuities, and cash flows that occur at irregular intervals or in groups. The examples are solved using a HP 10B II financial calculator to demonstrate the keystrokes needed.

Uploaded by

Rudini
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as PPT, PDF, TXT or read online on Scribd
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Internal Rate of Return (IRR) and

Net Present Value (NPV)


Net present value (NPV): the sum of the present values of all
cash inflows minus the sum of the present values of all
cash outflows.
The internal rate of return (IRR): (1) the discount rate that
equates the sum of the present values of all cash inflows
to the sum of the present values of all cash outflows;
(2) the discount rate that sets the net present value
equal to zero.
The internal rate of return measures the investment yield.

IRR and NPV


Example: Yield on a single receipt.
An investor can purchase a vacant lot for $28,371 and expects
to sell it for $50,000 in 5 years. What is the expected IRR for
this investment?

1
PV FV
(1 d )n
$28,371 $50,000
d = 12%

1
(1 d ) 5

IRR and NPV


HP 10B Keystrokes
CLEAR ALL
1

P/YR

28371

+/-

50000
5

N
I/YR

FV

PV

Clears registers
One payment per year
PV = -$ 28,371
FV = $ 50,000
FV in 5 years
Solve for IRR

IRR and NPV


Example: NPV for a single receipt.
An investor can purchase a vacant lot for $28,371 and expects to sell it for
$50,000 in 5 years. What is the expected NPV for this investment if the
investor discounts future cash flows at 15%?

1
NPV PV FV
n
(1 d )
1
NPV $28,371 $50,000
(1 015
. )5
NPV = -$28,371 + $24,858.84 = - $3,512.16

IRR and NPV


HP 10B Keystrokes
CLEAR ALL
1

P/YR

50,000 FV
15

I/YR

PV

+/28,371

Clears registers
One payment per year
$50,000 future value
Discount rate = 15%
FV in 5 years
Compute present value
Subtract $28,371

IRR and NPV


Example: Yield on an Ordinary Annuity
An investor has the opportunity to invest in real estate costing $28,371
today. The investment will provide $445.66 at the end of each month for the
next 8 years. What is the (annual) IRR (compounded monthly) for this
investment?
nk

1
PV PMT
d t
t 1 (1
)
k
96

1
$28,371 445.66
d t
t 1 (1
)
12
d
0.9167%; d 110%
.
12

IRR and NPV


HP 10B Keystrokes

CLEAR ALL

12
28,371

P/YR

+/-

PV

445.66 PMT
8
I/YR

x P/YR

Clears registers
Monthly compounding
PV = - $28,371
Monthly pmt = $445.66
96 months
Compute IRR

IRR and NPV


Example: NPV for an Ordinary Annuity
An investor has the opportunity to invest in real estate costing
$28,371 today. The investment will provide $445.66 at the end of
each month for the next 8 years. What is the NPV for this
investment if the investor discounts future cash flows monthly at a
10% annual rate?
96

1
NPV $28,371 445.66
010
. t
t 1
(1
)
12
NPV = - $28,371 + $29,369.66 = $998.66

IRR and NPV


HP 10B Keystrokes

CLEAR ALL
P/YR

12
445.66
10
8
PV

PMT

I/YR

x P/YR

+/28,371

Clears registers
Monthly payments
Monthly pmt = $445.66
Annual discount rate = 10%
96 monthly payments
Compute PV
Subtract $28,371

IRR and NPV


Example: What is the IRR for an investment that costs $96,000 today and
pays $1028.61 at the end of the month for the next 60 months and then pays
an additional $97,662.97 at the end of the 60th month?
nk

1
FV
PV PMT

d
d nk
t 1 (1 ) t
(1 )
k
k
60

1
$97,662.97
$96,000 $1,028.61

d t
d 60
t 1 (1
) (1 )
12
12

d/12 = 1.0921% ; d = 13.10%

IRR and NPV


HP 10B Keystrokes
CLEAR ALL

12
96,000

P/YR

+/-

PV

1,028.61 PMT
97,662.97 FV
5
I/YR

x P/YR

Clears registers
Monthly payments
PV = -$96,000
Monthly pmt = $1,028.61
FV = $97,662.97
60 months
Compute yield (IRR)

IRR and NPV


Example: NPV for an ordinary annuity with an addition lump
sum receipt at the end of the investment term.
What is the NPV for an investment that costs $96,000 today
and pays $1028.61 at the end of the month for the next 60
months and then pays an additional $97,662.97 at the end of
the 60th month if the investor discounts expected future cash
flows monthly at the annual rate of 13.1047%?
nk

1
FV

d t
d nk
t 1 (1
) (1 )
k
k
60
1
$97,662.97
NPV $96,000 $1,028.61

0131047
.
0131047
.
t 1 (1
)t (1
)60
12
12
NPV PV PMT

NPV = - $ 96,000 + $ 96,000 = $ 0

IRR and NPV


HP 10B Keystrokes

CLEAR ALL
12

P/YR

1,028.61 PMT
97,662.97 FV
5

x P/YR

13.1047
PV

I/YR

+/96,000

Clears registers
Monthly payments
Monthly pmt = $1,028.61
FV = $97,662.97
60 months of payments
Discount rate = 13.1047%
Compute PV
Subtract $96,000

IRR and NPV


Example: IRR for uneven cash flows.
What is the IRR for an investment that costs $100,000 today
and pays $20,000 one year from today; $35,000 two years from
today; and $75,000 three years from today?

$20,000 $35,000 $75,000


$100,000

2
(1 d ) (1 d )
(1 d )3
d 1159%
.

IRR and NPV


HP 10B Keystokes

CLEAR ALL
1

P/YR

100,000

+/-

20,000

CFj

35,000

CFj

75,000

CFj
IRR/YR

CFj

Clears registers
One payment per year
Initial CF = - $100,000
1st CF
= $ 20,000
2nd CF = $ 35,000
3rd CF = $ 75,000
Compute yield (IRR)

IRR and NPV


Example: NPV for uneven cash flows.
What is the NPV for an investment that costs $10,000 today,
$8,000 one year from today, $5,000 two years from today and
pays $15,000 three years from today and $25,000 four years
from today if future cash flows are discounted at 10%?

$8,000 $5,000 $15,000 $25,000


NPV $10,000

2
3
11
.
11
.
11
.
11
.4
NPV = -$10,000 - $7,272.73 - $4,132.23 + $11,269.72 + $17,075.34
= $ 6,940.10

IRR and NPV


HP 10B Keystrokes
CLEAR ALL
1

P/YR

10,000

+/-

CFj

8,000

+/-

CFj

5,000

+/-

CFj

15,000

CFj

25,000
10

CFj

I/YR
NPV

Clear registers
One payment per year
Initial CF = - $ 10,000
1st CF
= - $ 8,000
2nd CF = - $ 5,000
3rd CF = $ 15,000
4th CF = $ 25,000
Discount rate = 10%
Compute net present value

IRR and NPV


Example: IRR for grouped cash flows.
Compute the IRR for an investment that costs $92,725.60
today and is expected to pay $10,000 at the end of the year for
the next three years; $15,000 at the end of years 4 and 5; and
$100,000 at the end of year 6.
3

$10,000 5 $15,000 $100,000


$92,725.60

t
t
6
(
1

d
)
(
1

d
)
(
1

d
)
t 1
t 4
d = 12%

IRR and NPV


HP 10B Keystrokes
CLEAR ALL
1

P/YR

92,725.60 +/10,000 CFj


3
15,000
2

Nj
CFj
Nj

100,000 CFj
IRR/YR

CFj

Clears registers
One payment per year
Initial CF = - $ 92,725.60
1st grouped CF = $ 10,000
Occurs three times
2nd grouped CF = $ 15,000
Occurs twice
3rd CF = $ 100,000 (once)
Compute the yield (IRR)

IRR and NPV


Example: NPV for grouped cash flows.
Compute the NPV for an investment that costs $98,000 today and is
expected to pay $791.38 at the end of each month for 12 months; $850.73 at
the end of each month for the following 12 months; $914.54 at the end of
each month for the following 11 months and a balloon payment of
$107,491.18 at the end of month 36 if the investor discounts future cash
flows monthly at a 13% annual rate.

NPV = - $554.17 = - $98,000 +


12

24
35
1
1
1
$107,49118
.
$791.38
$850.73
$914.54

013
. t
013
. t
013
. t
013
. 36
t 1 (1
t 13 (1
t 25 (1
)
)
)
(1
)
12
12
12
12

IRR and NPV


HP 10B Keystrokes
CLEAR ALL
12

P/YR

98,000

+/-

791.38

CFj

12
850.73
12
914.54
11

N j
CFj
N j
CFj
N j

107,491.18
13

CFj

CFj

I/YR
NPV

Clear registers
Monthly payments
Initial CF = - $98,000
1st grouped CF = $791.38
Occurs 12 times
2nd grouped CF = $850.73
Occurs 12 times
3rd grouped CF = $914.54
Occurs 11 times
4th CF = $107,491.18 (once)
Discount rate = 13%
Compute net present value

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