Chapter 11. The Basics of Capital Budgeting. Net Present Value (NPV) Internal Rate of Return (IRR) Modified Internal Rate of Return (MIRR) Regular Payback Discounted Payback. What is capital budgeting?. Analysis of potential additions to fixed assets.
Download Policy: Content on the Website is provided to you AS IS for your information and personal use and may not be sold / licensed / shared on other websites without getting consent from its author.While downloading, if for some reason you are not able to download a presentation, the publisher may have deleted the file from their server.
Chapter 11
The Basics of Capital Budgeting
Net Present Value (NPV)
Internal Rate of Return (IRR)
Modified Internal Rate of Return (MIRR)
Regular Payback
Discounted Payback
Projects we’ll examine:
CF is the difference between CFL and CFS. We’ll use CF later.
Year
CFt
PV of CFt
0

100

$100.00
1
10
9.09
2
60
49.59
3
80
60.11
NPVL
=
$ 18.79
WACC = 10%
Excel: =NPV(rate,CF1:CFn) + CF0
Here, CF0 is negative.
Year
CFt
PV of CFt
0

100

$100.00
1
70
63.64
2
50
41.32
3
20
15.02
NPVS
=
$ 19.98
WACC = 10%
Excel: =NPV(rate,CF1:CFn) + CF0
Here, CF0 is negative.
Enter CFs into the calculator’s CFLO register.
CF0 = 100
CF1 = 10
CF2 = 60
CF3 = 80
Enter I/YR = 10, press NPV button to get NPVL = $18.78.
NPV= PV of inflows – Cost
= Net gain in wealth
IRR is the discount rate that forces PV of inflows equal to cost, and the NPV = 0:
Solving for IRR with a financial calculator:
Enter CFs in CFLO register.
Press IRR; IRRL = 18.13% and IRRS = 23.56%.
Solving for IRR with Excel:
=IRR(CF0:CFn,guess for rate)
If IRR > WACC, accept project.
If IRR < WACC, reject project.
WACC
NPV
NPV
L
S
0
$50
$40
5
33
29
10
19
20
15
7
12
20
(4)
5
NPV ($)
IRR > r
and NPV > 0
Accept.
r > IRR
and NPV < 0.
Reject.
r = 18.1%
r (%)
IRRL = 18.1%
NPV and IRR always lead to the same accept/reject decision for any given independent project.
NPV
L
S
%
r 8.7 r
IRRL
IRRs
If r < 8.7%: NPVL> NPVSIRRS> IRRL
CONFLICT
If r > 8.7%: NPVS> NPVL,
IRRS> IRRL
NO CONFLICT
0
1
2
3
Excel: =MIRR(CF0:CFn,Finance_rate,Reinvest_rate)
We assume that both rates = WACC.
10%
100.0
10.0
60.0
80.0
10%
66.0
12.1
10%
MIRR = 16.5%
100.0
158.1
PV outflows
TV inflows
$158.1
(1 + MIRRL)3
$100
=
MIRRL = 16.5%
Project L’s Payback Calculation
0
1
2
3
CFt
100
10
60
80
30
Cumulative
100
90
50
80
30
PaybackL= 2 + /
= 2.375 years
PaybackS= 1.600 years
Uses discounted cash flows rather than raw CFs.
0
1
2
3
10%
CFt
100
10
60
80
PV of CFt
100
9.09
49.59
60.11
Cumulative
100
90.91
41.32
18.79
Disc PaybackL = 2 + / = 2.7 years
41.32
60.11
0 1 2
WACC = 10%
800 5,000 5,000
Project P has cash flows (in 000s): CF0 = $800, CF1 = $5,000, and CF2 = $5,000.
NPV
IRR2 = 400%
450
0
WACC
100
400
IRR1 = 25%
800