13 12 required return do we accept or reject the

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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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