If irr is less than the cost of capital then youve

• No School
• AA 1
• Rozi.93
• 29

This preview shows page 27 - 29 out of 29 pages.

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

Subscribe to view the full document.

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
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
• Fall '19

What students are saying

• As a current student on this bumpy collegiate pathway, I stumbled upon Course Hero, where I can find study resources for nearly all my courses, get online help from tutors 24/7, and even share my old projects, papers, and lecture notes with other students.

Kiran Temple University Fox School of Business ‘17, Course Hero Intern

• I cannot even describe how much Course Hero helped me this summer. It’s truly become something I can always rely on and help me. In the end, I was not only able to survive summer classes, but I was able to thrive thanks to Course Hero.

Dana University of Pennsylvania ‘17, Course Hero Intern

• The ability to access any university’s resources through Course Hero proved invaluable in my case. I was behind on Tulane coursework and actually used UCLA’s materials to help me move forward and get everything together on time.

Jill Tulane University ‘16, Course Hero Intern

Ask Expert Tutors You can ask 0 bonus questions You can ask 0 questions (0 expire soon) You can ask 0 questions (will expire )
Answers in as fast as 15 minutes