The Investment Detective

Projects’ Free Cash Flows

(dollars in thousands)

Project number: 1 2 3 4 5 6
Initial investment (2,000) (2,000) (2,000) (2,000) (2,000) (2,000)
Year 1 330 1,666 - 160 280 2,200
2 330 334 - 200 280
3 330 165 - 350 280
4 330 - 395 280
5 330 - 432 280
6 330 - 440 280
7 330 - 442 280
8 1,000 - 444 280
9 - 446 280
10 - 448 280
11 - 450 280
12 - 451 280
13 - 451 280
14 - 452 280
15 10,000 (2,000) 280

Sum of cash flow 3,310 2,165 10,000 3,561 4,200 2,200

benefits
Excess of cash flow
over initial 1,310 165 8,000 1,561 2,200 200
investment
Payback period 7 2 15 6 8 1
(years)
NPV 73.09 (85.45) 393.92 228.22 129.70 -
IRR 10.87% 6.31% 11.33% 12.33% 11.12% 10.00%
Profitability Index 1.04 0.96 1.20 1.11 1.06 1.00
 7 8
(2,000) (2,000) If these projects
1,200 (350) are mutually exclusive, meaning that we can choose one project or the
900 (60) but not both
300 60
90 350
70 700 Evidence suggests that despite the theoretical superiority of NPV, finan
1,200 use the IRR approach just as often as the NPV method. The appeal of th
2,250 IRR technique is due to the general disposition of business people to th
terms of rates of return rather than actual dollar returns. Because inter
profitability, and so on are most often expressed as annual rates of ret
of IRR makes sense to financial decision makers. They tend to find NPV
because it does not measure benefits relative to the amount invested.
a variety of techniques are available for avoiding the pitfalls of the IRR,
widespread use does not imply a lack of sophistication on the part of fi
decision makers. Clearly, corporate financial analysts are responsible fo
and resolving problems with the IRR before the decision makers use it
decision technique.

2,560 4,150

560 2,150

2 7

165.04 182.98
15.26% 11.41%
1.08 1.09
an choose one project or the other

tical superiority of NPV, financial managers

NPV method. The appeal of the
ition of business people to think in
dollar returns. Because interest rates,
ressed as annual rates of return, the use
akers. They tend to find NPV less intuitive
tive to the amount invested. Because
oiding the pitfalls of the IRR, its
ophistication on the part of financial
al analysts are responsible for identifying
e the decision makers use it as a
 The Investment Detective
Projects’ Free Cash Flows
(dollars in thousands)

Project number: 1 2 3 4 5
Initial investment (2,000) (2,000) (2,000) (2,000) (2,000)
Year 1 330 1,666 - 160 280
2 330 334 - 200 280
3 330 165 - 350 280
4 330 - 395 280
5 330 - 432 280
6 330 - 440 280
7 330 - 442 280
8 1,000 - 444 280
9 - 446 280
10 - 448 280
11 - 450 280
12 - 451 280
13 - 451 280
14 - 452 280
15 10,000 (2,000) 280

Sum of cash flow benefits 3,310 2,165 10,000 3,561 4,200

Excess of cash flow over initial 1,310 165 8,000 1,561 2,200
investment
Payback period (years) 7 2 15 6 8

Rank Long term invest 3 1 2

Short term invest 4
 6 7 8
(2,000) (2,000) (2,000)
2,200 1,200 (350)
900 (60)
300 60
90 350
70 700
1,200
2,250

2,200 2,560 4,150

200 560 2,150

1 2 7

1 2 3
 The Investment Detective
Projects’ Free Cash Flows
(dollars in thousands)

Project number: 3 4 8 7 5 1
NPV 393.92 228.22 182.98 165.04 129.70 73.09
Project number: 7 4 8 3 5 1
IRR 15.26% 12.33% 11.41% 11.33% 11.12% 10.87%
Project number: 3 4 8 7 5 1
PI 1.20 1.11 1.09 1.08 1.06 1.04
Project number: 3 4 8 7 5 1
Payback period (years) 15 6 7 2 8 7

IRR
18.00%
16.00%
14.00%
12.00%
10.00%
8.00%
6.00%
4.00%
2.00%
0.00%
7 4 8 3 5 1 6 2

IRR

Project number: 7 4 5 3 1 6
Payback period (years) 2 6 8 15 7 1
Project number: 7 4 5 1 3 6
IRR 15.26% 12.33% 11.12% 10.87% 11.33% 10.00%
 6 2
- (85.45)
6 2
10.00% 6.31%
6 2
1.00 0.96
6 2
1 2

Chart Title
500.00

400.00

300.00

200.00

100.00

-
3 4 8 7 5 1 6 2
(100.00)

(200.00)

Payback period (years)

16

14

12

10

8
2 6
2
4

0
7 4 5 3 1 6 2
 6

0
7 4 5 3 1 6 2

IRR
18.00%
16.00%
14.00%
12.00%
10.00%

2 8.00%
6.31% 6.00%
4.00%
2.00%
0.00%
7 4 5 1 3 6
 Project nu NPV
3 393.92
4 228.22
8 182.98
7 165.04
5 129.70
1 73.09
6 -
2 (85.45)

2
 2

1 3 6 2