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Lessons Lesson7 Excel in Business - Lesson7

This document discusses cash flow analysis and capital budgeting techniques. It covers net present value (NPV) and internal rate of return (IRR) calculations. The key points are: 1) NPV is used to evaluate whether the present value of future cash flows exceeds the initial investment amount. A positive NPV means the investment generates profits in present value terms. 2) IRR is the discount rate that results in an NPV of zero. It represents the annual growth rate of an investment. IRR is not always uniquely defined for cash flows. 3) Both NPV and IRR are used to compare investment projects, but NPV is preferable since it incorporates a discount rate and results in

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Harsh Prasad
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45 views

Lessons Lesson7 Excel in Business - Lesson7

This document discusses cash flow analysis and capital budgeting techniques. It covers net present value (NPV) and internal rate of return (IRR) calculations. The key points are: 1) NPV is used to evaluate whether the present value of future cash flows exceeds the initial investment amount. A positive NPV means the investment generates profits in present value terms. 2) IRR is the discount rate that results in an NPV of zero. It represents the annual growth rate of an investment. IRR is not always uniquely defined for cash flows. 3) Both NPV and IRR are used to compare investment projects, but NPV is preferable since it incorporates a discount rate and results in

Uploaded by

Harsh Prasad
Copyright
© © All Rights Reserved
Available Formats
Download as PPTX, PDF, TXT or read online on Scribd
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IIIMIT - Excel in Business - Lesson 7

Lesson 7
Cash Flow Analysis
Excel in Business

Institute for Innovations &


Inventions with Mathematics and I.T.

Question 1
2

Consider the following cash flow:


Year
1
2
3

Payment @ end of
year
10,000
20,000
30,000

Would you pay Rs 55,000 today to get this


sequence of cash flow?
IIIMIT - Excel in Business - Lesson 7

Question 1(cont..)
3

10,000

20,000

30,000

Suppose the prevailing market rate is 10%


compounded annually.
Then the NPV of the payments is
NPV of
future
earnings
IIIMIT - Excel in Business - Lesson 7

Question 1(cont..)
4

If we paid Rs 55,000 today for them, the NPV


for the entire investment would be
Rs 55,000 + 48,159 = 6841,
a loss of Rs 6841 in todays terms.
On the other hand, if you are offered the same
future cash flows for Rs 45,000 then
NPV = Rs 45,000 + 48,159 = Rs 3159,
a profit of Rs 3,159 in todays terms.
IIIMIT - Excel in Business - Lesson 7

Application of NPV: Comparing two


projects
5

Which is a better investment plan?


Year
0
1
2
3

Project A
Project B
(in millions) (in millions)
-800
-800
600
400
400
400
200
400
IIIMIT - Excel in Business - Lesson 7

Application of NPV: Comparing two


projects(cont..)
6

Discount rate =10%

Since NPV(A) > NPV(B), project A is a better


investment than project B.
IIIMIT - Excel in Business - Lesson 7

To summarize:
7

NPV is used to make investment


decisions

A positive NPV represents profit, and

a negative NPV represents loss


(compared to letting your money
earn interest).

IIIMIT - Excel in Business - Lesson 7

NPV Function
8

NPV
Syntax:
= NPV (rate per period, cash flow
range)

The NPV function


Handles only end of the period payments
Does not include the initial investment
since it considers all payments end of the
Move to worksheet NPV,
first period onwards
IRR

IIIMIT - Excel in Business - Lesson 7

XNPV Function
9

XNPV
Syntax:
= XNPV (annual rate, cash flow range,
date)

The XNPV function handles the situation


when payments are made at unequal time
periods.
Move to worksheet XNPV,
XIRR
IIIMIT - Excel in Business - Lesson 7

NPV vs Rate
10
200
150
100
50

NPV

0
0.05

0.1

0.15

0.2

0.25

0.3

-50
-100
-150
-200

Rate
Project B (last example)
IIIMIT - Excel in Business - Lesson 7

0.35

0.4

0.45

Internal Rate of Return (IRR)


11

The internal rate of return (or IRR) of a cash


flow is defined as that annual rate of interest
which makes its NPV equal to zero.

IRR is viewed as measuring the annual rate


of growth of the investment.

IIIMIT - Excel in Business - Lesson 7

IRR
12
200
150

IRR

100
50

NPV

0
0.05

0.1

0.15

0.2

0.25

0.3

-50
-100
-150
-200

Rate
Project B (last example)
IIIMIT - Excel in Business - Lesson 7

0.35

0.4

0.45

IRR Function
13

SYNTAX:
= IRR (cash flow range)

Note that for using this function we must


include the initial investment also.

Move to worksheet NPV,


IRR
IIIMIT - Excel in Business - Lesson 7

XIRR Function
14

SYNTAX:
= XIRR (cash flow range, dates)

Note that for using this function we must


include the initial investment also.

Move to worksheet XNPV, XIRR


IIIMIT - Excel in Business - Lesson 7

IRR: A closer look


15

Two possible sources of trouble become


visible:
1. What if there is no rate of interest which
makes the NPV zero?
2. What if there are several rates of interest
which make the NPV zero?

IIIMIT - Excel in Business - Lesson 7

Example: No IRR exists


16

Year

Cash Flow

12000

10000

10000

-10000

8000

10000

NPV

6000
4000
2000
0
0

0.5

1.5

2
Rate

IIIMIT - Excel in Business - Lesson 7

2.5

3.5

Example: Multiple IRR


exists
17

800

240
0

100
1700

200
35
30
25
20

NPV

15
10
5
0
-50.5

1.5

-10

Rate
IIIMIT - Excel in Business - Lesson 7

2.5

3.5

IRR: A closer look


18

The situation, where there are several


solutions for IRR, is particularly common and
happens when a cash flow has many
intermingled positive and negative entries.
In such cases, none of the solutions can be
preferred over the others and the only
honest
description is to say that there is no IRR.
IIIMIT - Excel in Business - Lesson 7

IRR: A closer look


19

There is only one situation when IRR can


be safely defined. This is when the first
few entries have one sign, and the
remaining have the opposite.
For example: 100, 50, 45, 30, 0, 100,
400.

IIIMIT - Excel in Business - Lesson 7

NPV vs IRR
20

NPV
NPV is defined
for every cash
flow.

IRR
IRR is not always
defined for
every cash flow.

IIIMIT - Excel in Business - Lesson 7

NPV vs IRR
21

NPV
It is additive. The NPV
of a complicated
project can be
obtained by summing
up the individual NPVs
of its parts. This eases
book-keeping.

IRR
IRR is not
additive

IIIMIT - Excel in Business - Lesson 7

NPV vs IRR
22

NPV

IRR

To calculate NPV
one needs
market
information i.e.
market rates.

To calculate IRR,
no market
information is
needed.

IIIMIT - Excel in Business - Lesson 7

NPV vs IRR
23

NPV

IRR

It gives an
answer in terms
of absolute profit
and loss.
No sense of
Profit
Investment

It does not gives


any sense of
absolute profit
but does try to
estimate
Profit
Investment

IIIMIT - Excel in Business - Lesson 7

Goal Seek in Excel


24

If you know the result that you want


from a formula, but not the input value the
formula needs to get that result, you can
use the Goal Seek feature.
For e.g. if one wants to calculate the
value of x s.t. x2 + 3x+2 = 0, we can use
Goal seek tool of Excel.

IIIMIT - Excel in Business - Lesson 7

Goal Seek in Excel


25

Data What If Analysis Goal Seek

The formula
cell
The desired
value
The guess cell

Move to worksheet Goal Seek


IIIMIT - Excel in Business - Lesson 7

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