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# Lecture 4

Advanced Capital
Budgeting Techniques

6-1

 CFs are discounted by project cost of capital. 6-2 -1000 500 400 300 100 0 1 2 3 4 .Discounted PBP  Discounted PBP is ”the number of years required to recover the ICO from discounted future CFi”.

683 a 2 455 b 1000 331 786 c 786 225 1011 d 225 1079 Disc.Year CF-AT Discou Cum.95 68 79 6-3 . nted Disc DF@10% CF .8264 3 300 0.9091 455 2 400 0.7513 4 100 0.P BP 2. CF 0 -1000 1 -1000 1 500 0.

then Accept the project . ko=cost of capital or other rate) until the termination of the project.Net Terminal Value (NTV)   6-4 Each CFi is re-invested in other asset (project) at certain rate of return (i.e. 3-steps to find NTV: i) CFi are compounded at given re-investment rate to get the Terminal Value (TV) ii) Find PV of TV & CFo at ko rate iii) Calculate NTV: NTV = PV of TV – PV of CFo Decision Rule:  If NTV>0.

CFi=4. k=10%.000. CFi re-invested 0 1 2 3 6-5 4 .000 up to 5-years. -10000 4000 4000 4000 4000 4000 0 1 2 3 4 5 No of years. n=5 years. NTV: example CFo=10. re-investment rate: 6% for 1-2 years & 8% 3-5 years.

08 1.08 1.06 1.2625 5050 2 4000 3 0.0000 4000 TV 6-6 FV 22800 .08 1.0800 4320 5 4000 0 0.Step 1 Years CFi No of years.1910 4764 3 4000 2 0.06 1. Factor 1 4000 4 0.1664 4666 4 4000 1 0. CFi investe d Reinvestme nt rate Comp.

6209 14157 Step 3 PV of TV 14157 6-7 PV PV of Cfo 10000 NTV 4157 .-10000 22800 0 1 2 3 4 5 Step 2 Year CF-AT DF@10% 0 -10000 1.0000 -10000 5 22800 0.

the rate at which NPV becomes 0. OR. the rate at which NTV becomes 0. MIRR is the rate that equates PV of Costs (CFo) to PV of Terminal Value (TV). 6-8 . OR.  As IRR is the rate that equates PV of Costs (CFo) to PV of Benefits (CFi).Modified IRR (MIRR)  To overcome different problems in IRR. like multiple IRR. re-investment rate.  Similarly.

MIRR 2-steps to find MIRR: i) CFi are compounded at given reinvestment rate to get the Terminal Value (TV) ii) Now discount TV at such rate (MIRR). that equates it to PV of CFo: PV of TV – PV of CFo = 0 PV of CFo = TV / (1+MIRR)^n MIRR = (TV / CFo) ^ (1/n) .1 Decision Rule: 6-9  If MIRR > ko. then Accept the project .

1792 2 3 4 5 Check Year CF-AT 0.4386 10000 NTV 0 .MIRR example  Find Step 1 MIRR in previous example -10000 4000 4000 4000 4000 4000 0 1 2 3 4 5 -10000 22800 0 1 Step 2 6-10 n= 5 TV 22800 CFo 10000 MIRR 0.1792 PV 0 -10000 1 -10000 5 22800 0.