Unformatted text preview: ng projects with a “positive NPV,” subject to availability of capital. Fundamentally, the
mathematical basis of IRR is not much different than NPV.
The manual calculation of IRR using present value tables is a true pain. One would repeatedly try
rates until they zeroed in on the rate that caused the present value of cash inflows to equal the
present value of cash outflows. If the available tables are not sufficiently detailed, some
interpolation would be needed. However, spreadsheet routines are much easier. Let’s reconsider the
illustration for Greenspan. Below is a spreadsheet, using an interest rate of 8.8361%. Notice that this
rate caused the net present value to be zero, and is the IRR. This rate was selected by a higher-lower
guessing process (trying each interest rate guess in cell C7). This does not take nearly as many
guesses as you might think; with a little logic, you can quickly zero in on the exact correct rate. 5.6 Payback Method
The payback method could be called “investment decision making for dummies.” It is a popular and
easy method, and can be valuable when the key investment goal is to find projects where the initial
investment is quickly recovered. But, it is not very strong in otherwise pinpointing the best capital
Payback is calculated by dividing the initial investment by the annual cash inflow. The earlier
illustration for Greenspan has a payback of approximately 3.9 years ($500,000/$128,000 = 3.9). If
an investment involves uneven cash flows, the computation requires scheduling cash inflows and
outflows. The payback period is the point at which the cumulative net cash inflows begin to exceed
the cumulative net cash outflows. Download free ebooks at bookboon.com
33 Evaluation of Long-Term Projects Analytics for Managerial Decision Making The method is deficient in that it does not take into account the time value of money. It also fails to
reveal what happens after the payback period. For example, some investments may payback rapidly,
but have little residual cash flow after the payback period. Other investments may take years to
payback, and then continue to generate future returns for many more years to come. Although the
investment with the shorter payback may be viewed as favorable, it could easily turn out to be the
worst choice. All in all, be very cautious using the payback method for making business decisions. 5.7 Conclusion Please click the advert Capital budgeting decisions are not much different than the whole of managerial accounting. There
are many tools at your disposal. You should understand these tools and how to use them. But, in the
final analysis, good decision making will be driven by your own reasoned judgment. With us you can
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34 Appendix Analytics for Managerial Decision Making Future Value of $1 Table http://principlesofaccounting.com/ART/fv.pv.tables/fvo Appendix 35 1 of 1 8/10/2009 1:...
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