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F.Chap09

# You 32 32 another example nonconventional cash flows

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Unformatted text preview: accept or reject the project? 33 33 NPV Profile IRR = 10.11% and 42.66% \$4,000.00 \$2,000.00 NPV \$0.00 (\$2,000.00) 0 0.05 0.1 0.15 0.2 0.25 0.3 0.35 0.4 0.45 0.5 0.55 (\$4,000.00) (\$6,000.00) (\$8,000.00) (\$10,000.00) Discount Rate 34 34 Summary of Decision Rules The NPV is positive at a required return of The 15%, so you should Accept Accept If you use the financial calculator, you If would get an IRR of 10.11% which would tell you to Reject Reject You need to recognize that there are nonconventional cash flows and look at the conventional NPV profile NPV 35 35 IRR and Mutually Exclusive IRR Projects Projects Mutually exclusive projects If you choose one, you can’t choose the other Example: You can choose to attend graduate school at either Example: Harvard or Stanford, but not both Harvard Intuitively you would use the following decision rules: NPV – choose the project with the higher NPV IRR – choose the project with the higher IRR 36 36 Example With Mutually Exclusive Example Projects Projects Period Project Project A 0 -500 Project Project The required return B for both projects is -400 10%. 1 325 325 2 325 200 IRR Which project should you accept 19.43% 22.17% and why? NPV 64.05 60.74 37 37 NPV Profiles IRR for A = 19.43% \$160.00 \$140.00 IRR for B = 22.17% \$120.00 Crossover Point = 11.8% NPV \$100.00 \$80.00 A B \$60.00 \$40.00 \$20.00 \$0.00 (\$20.00) 0 0.05 0.1 0.15 0.2 0.25 0.3 (\$40.00) Discount Rate 38 38 Conflicts Between NPV and IRR NPV directly measures the increase in value to NPV the firm the Whenever there is a conflict between NPV and Whenever another decision rule, you should always use always NPV NPV IRR is unreliable in the following situations Non-conventional cash flows Mutually exclusive projects 39 39 Profitability Index Measures the benefit per unit cost, based Measures on the time value of money on A profitability index of 1.1 implies that for profitability every \$1 of investment, we create an additional \$0.10 in value This measure can be very useful in This situations in which we have limited capital situations 40 40 Advantages and Disadvantages Advantages of Profitability Index of Advantages Closely related to Closely NPV, generally leading to...
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