Presented By Amit Singh Devendra Kashyab Ramneek Kaur Gill Sudip Thakur Samarjit Sachin Kumar Tarisha Rathod

NPV And IRR have become the choices of decision makers to use in measuring the financial attractiveness of investment opportunities.
are used in wide variety situation like: 1. From equipment and real estate acquisition to company acquisition 2. From new product introduction decisions to decision to close down

Both

 NPV

reduces the future expected cash inflow from that investment at a rate that reflects three factors: 1. Investment Risk 2. Expected inflation 3. Better opportunity turn up.
IRR is the rate of percentage which when used as the discount rate, will cause the sum of discounted future inflows to exactly equal to the initial cash outflow.

 Neither

NPV nor IRR are equipped to deal with investment that have cash flow between the beginning and in the end of the investment is determined only by the size and timing of free cash flows, not by reinvestment rate.

IRR

 NPV

is expressed in absolute terms rather than relative terms and hence does factor in the scale of investment rule does not consider the life of the project, but when it consider the different lives , NPV rule biased in favor of the longer term project.

NPV

The cost of capital determines how a company can raise money .This is the rate of return that a firm would receive if it invested in a different vehicle with similar risk.

Gitam Defines the risk adjusted discount rate (RADR) as the rate of return that must be earned on a given project to maintain or improve the firm`s share price. RADR is also known as Hurdle rate

The minimum amount of return that a person requires before they will make an investment in something When hurdle rate is 7% and reinvestment rate is 7% . It tells us that in the future,firm is going to earn less then the cost of capital.

When RADRS are used, the advantage of NPV as a conservative measure of project attractiveness is significantly reduced

 Modified

internal rate of return (MIRR) is a variant of IRR that assumes that cash generated is re-invested at the cost of capital This is preferable because:

1. Any series of cash flows has a single MIRR.

2.It takes account of the rate at which cash generated is re-invested.

 The

MIRR calculation proceeds in three steps:

Discount the investment funds committed to the project back to the present at a hurdle rate that fairly represents the investment risk. Discount the free cash flows forward to a time horizon at a chosen reinvestment rate that represents expected future opportunities with risks equal to the investment risk Calculate the IRR

Problems with NPV and IRR:

NPV

and IRR are two period measures that cannot account for free cash flows between the periods RADR or hurdle rate does not reflect the risk associated with investment. NPV and IRR may rank mutually exclusive projects differently when size, timing or unequal lives are involved. IRR may exhibit multiple rates of return when cash flows go from negative to positive more than once.

 MIRR

value is always unique given that we have at least one negative and one positive net cash flow. The modified internal rate of return is a geometric average of the compounded future value of positive cash flows over the discounted present value of negative cash flows.

 Investment

Funds are required beyond the initial time period. Many opportunities require fixed capital outlays over 1 or more years and some may require at the same time as cash inflows.

Management

gets unrealistic view of an investments real potential because of assumptions about free cash flow.

 Problems

of size, timing, and rankings make comparison among alternatives difficult when budgets are limited or projects are mutually exclusive.

Issue

of size differential among among alternatives without incremental analysis.

 MIRR

is a more accurate measure of attractiveness of an investment alternative because attractiveness depends not only on ROI, but also on the return expected from cash flow it generates.

Hence

Executives seeking to hone their decision making skills will do well to consider the power of this measure.