Professional Documents
Culture Documents
Kiran Thapa
Importance
Irreversible decisions
Growth
Large amount of funds
Risk
Complex
National importance
Independent projects
Contingent projects
Replacement projects
Expansion of business
Diversification projects
== - or +
=+
=+
==+
Sales revenue
=..
Less: Cash expenses
= ..
EBDT Or savings
=
Less: Depreciation
=
Earnings before taxes
= .
Less: Income taxes
= .
Earnings after taxes
= .
Add: Depreciation
= .
Cash flow after taxes (CFAT) =..
Payback period
Profitability Index
Decision rules
Advantages of PBP
1.Simple and easy to understand.
2.Measure the liquidity.
3.Deals with the risk.
Decision rule:
ARR > target ARR = Accept the project.
ARR< target ARR = Reject the project
ARR contd.
Advantages
1.Simple and easy to understand.
2.Consider the profitability.
3.Based on accounting data
Disadvantages
1.Ignores time value of money.
2.Based on accounting profits rather CFAT.
Decision rule
NPV > 0 , Accept the project
NPV< 0, Reject the project
For independent projects: Positive NPV project
should be accepted.
For mutually exclusive projects: High positive
NPV project should be accepted.
NPV contd.
Advantages
1.Consider TVM
2.Uses Cash flows
3.Consistent with wealth maximization goal
Disadvantages
1.Involves difficult calculation
2.Difficult to determine required rate of return.
Profitability Index
Ratio of Total present value and net cash outlay
PI = TPV/NCO
Decision rule
PI > 1, Accepted
PI< 1, Rejected
Same accept and reject decision as NPV but
ranking may be different.
Merit and demerits are same as NPV method.
Decision rule:
IRR> cost of capital = Accept
IRR< cost of capital = Reject
IRR contd
Merits
1.Consider the time value of money.
2.Consider the all cash flows
3.Consistent with wealth maximization goal.
Demerits
1.Involves tedious and complicated calculation
2.Produces multiple IRR
3.Future cash inflows are reinvested at IRR rate.
MIRR contd
Merits
1.MIRR gives single correct answer
2.Cash flows are reinvested at cost of capital.
3.Consider the TVM.
Demerits
1.It involves difficult calculations
2.MIRR suffer from some other drawbacks of
IRR.
Any queries?
?
Thank You
NPV vs IRR
Problems
ABC company needs a car. There are two car
options. Each type of car will cost Rs 50,000.
The life of first car is 10 years and provide an
after tax cash flow of Rs 9,500 per year. The
second car will last for 15 years, and their
annual after tax cash flow is estimated as Rs
8,140. The required rate of return of the
company is 10 percent. Which car is better
buy?
Ans: Infinity horizon NPV1 = Rs 13,630 and NPV 2 = 15,660
Problems contd.
Contd.
Ans:
a. - 345,000
b. 30,000;
c. 42,000;
d. 135,000;
e. 64,221.6
Ans:
Ans:
NCO = - 62,200
Diff. Dep = 6,000
CFAT = 14,400 for 4 years
5th year = 14,400 + 20,000 + 5000 = 39,400
K = 11.97% or 12%
NPV = 3,894.12
PBP = 4.12 years
IRR = 14.116%
Problems