If NPV > 0 with that rate, try again with a higher rate•If NPV < 0 with that rate, try again with a lower rate•If NPV = 0 with that rate, then that discount rate is the IRRIRR can be found much more easily and quickly with a financial calculator

dgeting criteria - 30Financial Calculator: TI-83 PlusFinding IRR: TI-83 PlusGo into the IRR function by pressing the APPS key, then pressing 1 (for finance applications), and then pressing 8 (for IRR function)“irr(” should appear on screenType in the appropriate numbers to fill in the following: irr(C0, {C1, C2, …, last non-zero expected cash flow})Press ENTER and calculator finds IRR•0 = C0+ [C1/(1+IRR)1] + [C2/(1+IRR)2] +…+ [Ct/(1+IRR)t]Note that the IRR function does not involve the sign convention as all expected cash flows are entered with their actual sign and the calculator-produced IRR is the IRR•Positive for inflows and negative for outflows

dgeting criteria - 31Capital Budgeting Criteria:IRR – ExampleWould we accept the finance-tutor project based on its IRR?Step 1: expected cash flows are given• C0= -165,000; C1= 65,000; C2= 70,000; C3= 90,000Step 2: discount rate is given as 12%Step 3: compute IRR•irr(-165000,{65000,70000,90000})•Press ENTER•16.25 should appear, so IRR = 16.25%Step 4: IRR = 16.25% > 12%, so accept project

dgeting criteria - 32Capital Budgeting Criteria:IRR – ExampleIf Patriot Theaters believes that opening a Boston multiplex would cost $550,000 today and would produce expected cash flows of $100,000, $200,000, $300,000, and $400,000 in 1, 2, 3, and 4 years, would the firm choose to expand, based on IRR, if the cost of capital associated with the project is 23.4 percent?Step 1: expected cash flows are given• C0= -550,000; C1= 100,000; C2= 200,000; C3= 300,000; C4= 400,000Step 2: discount rate is given as 23.4%Step 3: compute IRR•irr(-550000,{100000,200000,300000,400000})•Press ENTER•22.96 should appear, so IRR = 22.96%Step 4: IRR = 22.96% < 23.4%, so do not accept project

dgeting criteria - 33Capital Budgeting Criteria: IRRKey strengths of IRR and IRR ruleAppealing because it is a rateRecognizes the time value of moneyRecognizes project riskDecision rule is not based on managerial discretion, but on economic principlesFor projects with conventional cash flows, rule always leads to acceptance of projects that create value and always leads to rejection of projects that destroy value•Produces same results as NPV rule for these types of projects

dgeting criteria - 34Capital Budgeting Criteria: IRRKey weaknesses of IRR and IRR ruleFor projects with non-conventional cash flows, the decision rule may not be clearly applicable, as there may be more than one IRR or no IRRFor projects with non-conventional cash flows, rule can lead to rejection of projects that create value and can lead to acceptance of projects that destroy value•Positive NPV projects may be rejected•Negative NPV projects may be accepted

dgeting criteria - 35Capital Budgeting Criteria: IRRThree important cases when IRR rule should not be usedPositive expected cash flow or flows and then negative expected cash flow or flowsExpected cash flows that flip sign more than once•