**Unformatted text preview: **urn, reject.
reject Rationale for the IRR method
Rationale If IRR > WACC, the project’s rate of
If
return is greater than its costs. There is
some return left over to boost
stockholders’ returns.
stockholders’ IRR Acceptance Criteria
IRR If IRR > k, accept project. If IRR < k, reject project. If projects are mutually exclusive, accept
If
the highest IRR(must > k).
the IRR is a good decision-making tool as
IRR
long as cash flows are conventional.
conventional
(- + + + + +)
( Problem: If there are multiple sign
changes in the cash flow stream, we
could get multiple IRRs. (- + + - + +)
(- IRR is a good decision-making tool as
IRR
long as cash flows are conventional.
conventional
(- + + + + +)
( Problem: If there are multiple sign
changes in the cash flow stream, we
could get multiple IRRs. (- + + - + +)
(- (500) 200 100 (200) 400 300 0 1 2 3 4 5 IRR is a good decision-making tool as
IRR
long as cash flows are conventional.
conventional
(- + + + + +)
( Problem: If there are multiple sign
changes in the cash flow stream, we
could get multiple IRRs. (- + + - + +)
(1
(500) 200 100 (200) 400 300 0 1 2 3 4 5 IRR is a good decision-making tool as
IRR
long as cash flows are conventional.
conventional
(- + + + + +)
( Problem: If there are multiple sign
changes in the cash flow stream, we
could get multiple IRRs. (- + + - + +)
(1 2 (500) 200 100 (200) 400 300 0 1 2 3 4 5 IRR is a good decision-making tool as
IRR
long as cash flows are conventional.
conventional
(- + + + + +)
( Problem: If there are multiple sign
changes in the cash flow stream, we
could get multiple IRRs. (- + + - + +)
(1 2 3 (500) 200 100 (200) 400 300 0 1 2 3 4 5 Multiple IRRs
IRR IRR When project cash flows have multiple sign changes, there can be
multiple IRRs.
63
63 Which IRR do we use? NPV Profiles
NPV A graphical representation of project NPVs at various
graphical
different costs of capital.
different
k
0
5
10
15
20 NPVL
NPV
$50
33
19
7
(4) NPVS
NPV
$40
29
20
12
5 Drawing NPV profiles
Drawing
NPV 60
($) .
40 .
50 30 .
. 20 Crossover Point = 8.7% . 10 IRRL = 18.1% L .
. 0
5
-10 10 15 S .
. 20 .
23.6 IRRS = 23.6%
Discount Rate (%) Comparing the NPV and IRR methods
Comparing If projects are independent, the two
If methods always lead to the same
accept/reject decisions.
accept/reject If projects are mutually exclusive … If k > crossover point, the two methods lead
If
to the same decision and there is no conflict.
to If k < crossover point, the two methods lead
If
to different accept/reject decisions.
to Reinvestment rate assumptions
Reinvestment NPV method assumes CFs are reinvested at k,
NPV the opportunity cost of capital.
the IRR method assumes CFs are reinvested at
IRR
IRR.
IRR. Assuming CFs are reinvested at the
Assu...

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