Capital budgeting and decision making

# To if k crossover point the two methods lead if to

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Unformatted text preview: ming opportunity cost of capital is more realistic, so NPV method is the best. NPV method should NPV NPV be used to choose between mutually exclusive projects. projects. Perhaps a hybrid of the IRR that assumes cost Perhaps of capital reinvestment is needed. of Is there a better IRR measure? Is Yes, MIRR is the discount rate that causes the Yes, PV of a project’s terminal value (TV) to equal the PV of costs. TV is found by compounding inflows at WACC. WACC MIRR assumes cash flows are reinvested at the MIRR WACC. WACC. Calculating MIRR Calculating WACC 0 -100.0 10% 1 2 3 10.0 60.0 80.0 66.0 12.1 10% 10% MIRR = 16.5% -100.0 PV outflows \$100 = \$158.1 (1 + MIRRL)3 MIRRL = 16.5% 158.1 TV inflows In making the capital budgeting decision, each of the 5 decision methods gives decision makers with a somewhat different piece of relevant information. Since it is easy to calculate all of them, all should be considered in the decision process. For most decisions, the greatest weight should be given to the NPV and MIRR NPV Payback and discounted payback provide an indication of both the risk and Payback risk the liquidity of a project. liquidity NPV is important because it gives a direct measure of the dollar benefit (on NPV a present value basis) of the project to the firm’s shareholders, so it is regarded as the best single measure of profitability. the IRR also measures profitability, but expressed as a percentage rate of IRR return, which many decision makers seem to prefer. IRR also contains return which information regarding a project’s “safety margin.” information The modified IRR (MIRR) has all the virtues of the IRR ; however, it however, incorporates the correct reinvestment rate assumption, and it avoids reinvestmen rate problems the IRR can have when applied to projects with nonnormal cash flows.(so, now you can use TVM table) flows.(so,...
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