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

By using either trial and error or a financial

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Unformatted text preview: sing either trial-and-error or a financial calculator or Excel you get: IRR=14.49% BAFI 355 – Spring 2010 19-4 The NPV Profile The NPV Profile NPV profile is the graph relating the NPV of the project to the discount rate. For project S we derive: Discount Rate 0.0 2.5 5.0 7.5 10.0 12.5 15.0 17.5 20.0 22.5 25.0 NPV \$300.00 \$237.71 \$180.42 \$127.62 \$78.82 \$33.62 (\$8.33) (\$47.35) (\$83.72) (\$117.68) (\$149.44) \$400.00 NPV \$300.00 IRR \$200.00 \$100.00 Discount rate \$0.00 (\$100.00) 0 5 10 15 20 25 (\$200.00) (\$300.00) If we graph the NPV profile, we can see the IRR as the x-axis intercept BAFI 355 – Spring 2010 19-5 The IRR Rule: Details Details Rationale for the IRR rule IRR is the project’s expected rate of return. If IRR exceeds cost of funds used to finance the project, some surplus will remain fi On the decision: Minimum acceptance criteria: Accept project if IRR is greater than th the required return, that is, greater than the hurdle rate th th th t Ranking criteria: Select project with highest IRR Strengths Easy to understand and communicate It takes into consideration the time value of money It takes into consideration ALL cash flows However, there are problems with the IRR approach Are We Borrowing or Lending? Multiple IRRs The...
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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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