2 For example it is fairly easy to understand the meaning of the following

2 for example it is fairly easy to understand the

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(2) For example, it is fairly easy to understand the meaning of the following statement: 'The project will be expected to have an initial capital outlay of $100,000, and to earn a yield of 25%. This is in excess of the target yield of 15% for investments.' (3) Managers may confuse IRR and accounting return on capital employed, ROCE . (4) IRR method ignores the relative size of investments. Both the following projects have an IRR of 18%. Project A ($) Project B ($) Cost, year 0 350,000 35,000 Annual savings, years 1-6 100,000 10,000 Clearly, project A is bigger (ten times as big) and so more 'profitable' but if the only information on which the projects were judged were to be their IRR of 18%, project B would be made to seem just as beneficial as project A, which is not the case.
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___________________________________________________________________________________________________________________ Page 8 of 9 IPK COLLEGE 1664, JALAN KULIM, 14020 BUKIT MERTAJAM, PENANG TEL : 012-5203212 / 0125113212 / 04-5512588 Subject: Financial Management (DFM1) Prepared by N.Thacharyane Email : [email protected] Part 5: Non-conventional cash flows (1) Conventional cash flows (an initial cash outflow followed by a series of inflows) must be considered. (2) When the flows vary from this they are termed non-conventional. Part 6: Mutually exclusive projects (1) Mutually exclusive projects are two or more projects from which only one can be chosen . (2) The company is considering two mutually exclusive options, option A and option B. The cash flows for each would be as follows: Year Option A ($) Option B ($) 0 Capital outlay (10,200) (35,250) 1 Net cash inflow 6,000 18,000 2 Net cash inflow 5,000 15,000 3 Net cash inflow 3,000 15,000 The company’s cost of capital is 16%. Part 7: Comparison between NPV and IRR (1) When cash flow patterns are conventional both methods gives the same accept or reject decision . (2) The IRR method is more easily understood . (3) NPV is technically superior to IRR and simpler to calculate. (4) IRR and accounting ROCE can be confused . (5)IRR ignores the relative sizes of investments. (6) Where cash flow patterns are non-conventional, there may be several IRRs which decision makers must be aware of to avoid making the wrong decision. (7) The NPV method is superior for ranking mutually exclusive projects in order of attractiveness. (8) The reinvestment assumption underlying the IRR method cannot be substantiated . (9) When discount rates are expected to differ over the life of the project, such variations can be incorporated easily into NPV calculations, but not into IRR calculations. (10) Despite the advantages of the NPV method over the IRR method, the IRR method is widely used in practice.
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___________________________________________________________________________________________________________________ Page 9 of 9 IPK COLLEGE 1664, JALAN KULIM, 14020 BUKIT MERTAJAM, PENANG TEL : 012-5203212 / 0125113212 / 04-5512588 Subject: Financial Management (DFM1) Prepared by N.Thacharyane Email : yane @ipk.edu.my Part 8: Assessment of DCF methods of project appraisal (1) Advantages of DCF methods over other appraisal methods: (a)The time value of money is taken into account. (b)The method takes account of all of a project's cash flows. (c)It allows for the timing of cash flows (d)There are universally accepted methods of calculating the NPV and IRR.
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  • Spring '17
  • JANE KDAL

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