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MODULE REVISION
Independent Versus Mutually Exclusive Investment Projects
2
Evaluating Independent Investment Opportunities
3
Evaluating Mutually Exclusive Investment Opportunities
4
Evaluating Mutually Exclusive Investment Opportunities (cont.)
5
Evaluating Mutually Exclusive Investment Opportunities (cont.)
2. Firm Constraints –
Firm may face constraints such as limited
managerial time or limited financial capital
that may limit its ability to invest in all the
positive NPV opportunities.
6
Choosing Between Mutually Exclusive Investments
7
Net Present Value
• Net present value (NPV) is the excess of the present value
(PV) of cash inflows generated by the project over the
amount of the initial outlay (IO):
Decision rule: If NPV is positive, accept the project. Otherwise, reject it.
10
Q2:- NPV Calculation
You have been asked to consider the viability of the
following project
Advantages
The advantage of using the IRR method is that it
does consider the time value of money
Disadvantages
The shortcomings of this method are:
• it is time-consuming to compute, especially when the cash inflows are
not even, although most business calculators and spreadsheet software
have a program to calculate IRR
• it fails to recognize the varying sizes of investment in competing
projects and their respective dollar profitabilities.
• it sometimes generate multiple IRRs
Advantages and Disadvantages of the NPV and IRR Methods
Advantages:
With the NPV method, the advantage is that it is a direct
measure of the dollar contribution to the stockholders.
With the IRR method, the advantage is that it shows the
return on the original money invested.
Disadvantages:
With the NPV method, the disadvantage is that the project
size is not measured.
With the IRR method, the disadvantage is that, at times, it
can give you conflicting answers when compared to NPV for
mutually exclusive projects. The 'multiple IRR problem' can
also be an issue, as discussed below.
Multiple Internal Rate of Return (IRR)
Time 0 1 2
Cash flow -$60,000 155,000 -100,000
(a) 25%
(b) 33.33%.
Profitability Index PI
Profitability Index (Benefit/Cost Ratio)
The MIRR forces cash flow reinvestment at the cost of capital rather
than the project’s own IRR, which was the problem with the IRR.