Lecture 19 - Capital Budgeting - NPV and Other Criteria (II)

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Unformatted text preview: Unfortunately, MIRR is also known as meaningless IRR BAFI 355 – Spring 2010 19-12 Conflicts Between NPV and IRR: Summary Summary Take the cost of capital at 5%, which is below the crossover NPV directly measures the increase in value to the firm Whenever there is a conflict between NPV and another decision rule, you should always use NPV IRR is unreliable in the following situations Non-conventional cash flows Mutually exclusive projects exclusive projects BAFI 355 – Spring 2010 19-13 Capital Budgeting: Decision Rules Decision Rules The methods Net present value (NPV) Payback Discounted payback Internal rate of return (IRR) Profitability Index (PI) BAFI 355 – Spring 2010 19-14 The Profitability Index Rule The Profitability Index Rule Profitability Index (PI) Total PV of Future Cash Flows PV of Future Cash Flows PI= Initial Investment Example: PI for Project S 0 1 2 3 4 500 400 300 100 r=5% - 1,000 PV of future cash flows: = 500 400 300 100 + + + = 1,078.82 (1 + .05)1 (1 + .05) 2 (1 + .05) 3 (1 + .05) 4 Hence, PI is: PI = BAFI 355 – Spring 201...
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This note was uploaded on 05/28/2013 for the course BAFI 355 taught by Professor Mahnic during the Spring '09 term at Case Western.

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