If irr is less than the cost of capital then youve

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If IRR is less than the cost of capital, then you’ve got a BAD project on your hands (don’t undertake the project…). If the IRR and cost of capital are equal, then you should use another method to evaluate the project! Basically, the higher the IRR, the better the project
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28 55 Is IRR always a good choice? IRR is useful in deciding whether or not to invest in a single project When multiple projects are being considered, IRR is not a good investment tool to use to evaluate which project to choose. 56 Profitability Index (PI) A profitability index attempts to identify the relationship between the costs and benefits of a proposed project. The profitability index is calculated by dividing the present value of the project's future cash flows by the initial investment. A PI greater than 1.0 indicates that profitability is positive, while a PI of less than 1.0 indicates that the project will lose money. The PI ratio is calculated as follows: PV of Future Cash Flows Initial Investment
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29 57 Profitability Index (PI) - Explanation: Profitability index is actually a modification of the net present value method. While present value is an absolute measure (i.e. it gives as the total dollar figure for a project), the Profitability index is a relative measure (i.e. it gives as the figure as a ratio). Decision Rule Accept a project if the profitability index is greater than 1, stay indifferent if the profitability index is zero and don't accept a project if the profitability index is below 1. Profitability index is sometimes called benefit-cost ratio too and is useful in capital rationing since it helps in ranking projects based on their per dollar return. 58 Profitability Index (PI) - Example Company C is undertaking a project at a cost of $50 million which is expected to generate future net cash flows with a present value of $65 million. Calculate the profitability index. Solution Profitability Index = PV of Future Net Cash Flows / Initial Investment Required Profitability Index = $65M / $50M = 1.3 Net Present Value = PV of Net Future Cash Flows Initial Investment Rquired Net Present Value = $65M-$50M = $15M. The information about NPV and initial investment can be used to calculate profitability index as follows: Profitability Index = 1 + (Net Present Value / Initial Investment Required) Profitability Index = 1 + $15M/$50M = 1.3
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