Professional Documents
Culture Documents
Pres CH 5
Pres CH 5
Topics Covered
A Review of the Basics
The Payback Period
book income
Book rate of return
book assets
Payback Period
Payback Period
IRR 28 .08 %
Internal Rate of Return
Internal Rate of Return
Pitfall 1: Lending or Borrowing?
NPV of project increases as discount rate
increases for some cash flows
Internal Rate of Return
Pitfall 2: Multiple Rates of Return
Certain cash flows generate NPV = 0 at two
different discount rates
Following cash flow generates NPV = $A2.53
billion at 10% discount rate. NPV=0 at IRR of
3.5% and 19.54%
Multiple Rates of Return
Internal Rate of Return
Pitfall 2: Multiple Rates of Return
Project can have 0 IRR and positive NPV
Internal Rate of Return
Pitfall 3: Mutually Exclusive Projects
IRR sometimes ignores magnitude of project
Internal Rate of Return
Pitfall 4: More than One Opportunity
Cost of Capital
Assumes that the discount rates are stable
during the term of the project
Implies that the project cash flows are
optimal project
Choosing Capital Investments
when Resources are Limited
Cash Flows ($millions)
Project C0 C1 C2 NPV at 10% Profitability
Index
A -10 +30 +5 21 2.1
B -5 +5 +20 16 3.2
C -5 +5 +15 12 2.4
NPV
Profitabil ity index
investment
Example:
Select best projects for $300,000
Project NPV Investment PI
A 230,000 200,000 1.15
B 141,250 125,000 1.13
C 194,250 175,000 1.11
D 162,000 150,000 1.08
BMA2017: Chapter 5
All Examples
Exercises: 1, 3, 8, 12, 14, 15