Chapter 7 lecture

We are looking at a classic size disparity we problem

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Unformatted text preview: l deemed • When ranking projects, high IRR is When preferred over low IRR preferred 6 But, 7 NPV of IRR? – We are looking at a classic “size disparity We problem” problem” – A more extreme example: 8 NPV of IRR? – Finance theory: • “Always choose the project with the highest Always NPV” NPV” • Why? – Again, NPV is a more direct measure of “shareholder Again, happiness” happiness” • What would be the argument for project B? • Which project would you prefer as a Which shareholder? shareholder? 9 When do IRR & NPV give When the same answer? the – With all ‘conventional’ projects that are With independent and follow the typical pattern of initial negative cash flow followed by positive cash flows, whenever positive – IRR > r, then automatically – NPV > 0 10 Ranking Projects – Recall projects A & B: @8%: CFA PV(CF) CFB PV(CF) 0 -100000 -100000 1 30000 27,778 15000 13,889 2 30000 25,720 15000 12,860 3 30000 23,815 15000 11,907 4 30000 22,051 15000 11,025 5 30000 20,417 105000 71,461 PV(inflows) 119,781 121,143 NPV 19,781 21,143 IRR 15.24% 13.47% – Besides size disparity, different patterns of Besides cash flows can produce conflicting results cash 11 Investment Profile NPV(A)<NPV(B) • Comparing Investments A & B NPV(B)>NPV(A) $70,000 $60,000 $50,000 $40,000...
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