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opportunity cost of capital is more realistic, so
NPV method is the best. NPV method should
be used to choose between mutually exclusive
projects. Perhaps a hybrid of the IRR that assumes cost
of capital reinvestment is needed.
of Is there a better IRR measure?
Is Yes, MIRR is the discount rate that causes the
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
WACC. Calculating MIRR
-100.0 10% 1 2 3 10.0 60.0 80.0
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
the liquidity of a project.
liquidity NPV is important because it gives a direct measure of the dollar benefit (on
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
return, which many decision makers seem to prefer. IRR also contains
information regarding a project’s “safety margin.”
information The modified IRR (MIRR) has all the virtues of the IRR ; however, it
incorporates the correct reinvestment rate assumption, and it avoids
problems the IRR can have when applied to projects with nonnormal cash
flows.(so, now you can use TVM table)
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This document was uploaded on 02/03/2014.
- Spring '14
- Internal Rate Of Return (IRR)