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**Unformatted text preview: **0.16 0.18 0.2 0.22 -20,000
Discount Rate
26
26 Decision Criteria Test - IRR Does the IRR rule account for the time value of
Does
money?
money?
Does the IRR rule account for the risk of the
Does
cash flows?
cash
Does the IRR rule provide an indication about
Does
the increase in value?
the
Should we consider the IRR rule for our primary
Should
decision criteria?
decision 27
27 Advantages of IRR Knowing a return is intuitively appealing
It is a simple way to communicate the value of a
It
project to someone who doesn’t know all the
estimation details
estimation
If the IRR is high enough, you may not need to
If
estimate a required return, which is often a
difficult task
difficult 28
28 Summary of Decisions for the
Summary
Project
Project
Summary
Net Present Value Accept Payback Period Reject Discounted Payback Period Reject Average Accounting Return Reject Internal Rate of Return Accept
29
29 Calculating IRRs With A
Calculating
Spreadsheet
Spreadsheet You start with the cash flows the same as you
You
did for the NPV
did
You use the IRR function You first enter your range of cash flows, beginning
You
with the initial cash flow
with
You can enter a guess, but it is not necessary
The default format is a whole percent – you will
The
normally want to increase the decimal places to at
least two
least 30
30 NPV vs. IRR NPV and IRR will generally give us the
NPV same decision
same Exceptions Non-conventional cash flows – cash flow
Non-conventional
signs change more than once
signs
Mutually exclusive projects
• Initial investments are substantially different
• Timing of cash flows is substantially different 31
31 IRR and Non-conventional Cash
IRR
Flows
Flows When the cash flows change sign more than
When
once, there is more than one IRR
once,
When you solve for IRR you are solving for the
When
root of an equation and when you cross the xroot
axis more than once, there will be more than
axis
one return that solves the equation
one
If you have more than one IRR, which one do
If
you use to make your decision?
you 32
32 Another Example – Nonconventional Cash Flows Suppose an investment will cost $90,000
Suppose
initially and will generate the following cash
flows:
flows: Year 1: 132,000
Year 2: 100,000
Year 3: -150,000 The required return is 15%.
Should we...

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