Cost of the machine $ 80,000 Initial outlay (IO)

Annual contribution margin $ 15,000 cash inflows (CFt) => equal cash flow every year (annuit
Life of machine (n) 10 years
Cost of capital ( r) 6%

NPV = $30,401

PV of annuity of 1 =

NPV decision criteria

NPV >=0 => accept
NPV <0 => Reject
NPV is the preferred method. Decision should be made based on NPV
IRR (internal rate of return) is the rate of return at which NPV = 0

To determine IRR:
- Use calculator
- Trial and error (excel)
- Interpolation
+ Choose r1 that NPV1 > 0
+ Choose r2 that NPV2 < 0
+ r1<r2

Lecture example
R1 = 6%, NPV1 = $30,401
Find r2, that NPV2 is negative. If r increase, NPV will decrease. Choose r2 higher than r1
to make NPV lower and negative. Let select r2 = 15%
NPV2 = -80,000+15,000*5.019 = -4,718

IRR decision criterial

- IRR > r => Accept
- IRR < r => Reject
- A project can have multiple IRR. If the project cash flows change sign more than once,
it will have multiple IRR
- If multiple IRR => Hard to make decision => come back to NPV method.

Payback: number of years it takes the project to recoup the initial investment
Payback decision criterial: the shorter the payback, the better the project

The advantage of payback:

- Easy to understand
- Easy to calculate
Disadvantage of payback
- Ignore the time value of money
- Does not take into account the cash flows after the payback

ARR (Accounting rate of return)

Increase in annual contribution margin = $15,000

Operating income = Contribution margin - Fixed costs
Fixed costs: Depreciation of the machine
Depreciation of machine =

Advantage of ARR:
- Easy to understand
- Data can be taken from the financial statement
Disadvantage of ARR
- Ignore the time value of money
- Accounting income is affected by accrual accounting and not the same as cash flows
cash flow every year (annuity)
IO
r
useful life
Uneven cash flows

1. Net present value

Present value of savings in cash oper
Amount
$ 25,000
$ 22,000
$ 21,000
$ 20,000
Present value of savings in cash oper

Net initial investment

Net present value

2. Payback period

Year
0
1
2
3
4

3. Discounted payback period

Year
0
1
2
3
4

Using discounted payback, the projec

4. Internal rate of return (using the in

Find r1 at which NPV1>0 (positive
Find r2 at which NPV1<0 (negative
r2>r1

At 18% NPV is negative at -$4,916

=> r2 = 18% and NPV2 = -4,916
To find r1 at which NPV1 > 0 => low
Select r1 =

Amount
$ 25,000
$ 22,000
$ 21,000
$ 20,000
Present value of savings in cash oper

Net initial investment

Net present value (NPV1)

5. Average annual savings in cash op

$ 22,000.00
Annual depreciation
ARR
 $ 65,000 Year Amount RRR (table 2-page 952)
18% 1 $ 25,000 0.847 vì đây là từng cash flow khác n
4 years 2 $ 22,000 0.718
neven cash flows 3 $ 21,000 0.609
4 $ 20,000 0.516

Net present value

esent value of savings in cash operating costs:
RRR PV
0.847 21,186
0.718 15,800
0.609 12,781
0.516 10,316
esent value of savings in cash operating costs
60,084
et initial investment (65,000)
et present value (4,916)

Payback period - Calculate cumulative cash flows over time

- When cumulative cash flows change sign, then that is the payback

Cash Savings Commulative Net Initial investment

(CF) cash savings unrecovered at end of year
- - 65,000
$ 25,000 25,000 40,000
$ 22,000 47,000 18,000
$ 21,000 68,000 -
$ 20,000 -

or 2 years and 10 months

Discounted payback period

Cumulative
Cash savings Discounted discounted cash
(CFs) Discount factor cash savings savings
(65,000) 1.000 (65,000) (65,000)
25,000 0.847 21,175 (43,825)
22,000 0.718 15,796 (28,029)
21,000 0.609 12,789 (15,240)
20,000 0.516 10,320 (4,920)

sing discounted payback, the project can not payback within 4-year period

Internal rate of return (using the interpolation method)

nd r1 at which NPV1>0 (positive NPV called NPV1)
nd r2 at which NPV1<0 (negative NPV called NPV2)

18% NPV is negative at -$4,916

> r2 = 18% and NPV2 = -4,916
o find r1 at which NPV1 > 0 => lower discount rate
10%

RRR PV
0.909 22,727
0.826 18,182
0.751 15,778
0.683 13,660
esent value of savings in cash operating costs
70,347
et initial investment (65,000)
et present value (NPV1) $ 5,347

Average annual savings in cash operating costs

nnual depreciation $ 16,250

8.85%
page 952)
vì đây là từng cash flow khác nhau

n that is the payback

Initial outlay = Cost of machine + worki
= 94,000+4,000 =
Annual cash flow
Project life 6
End of year 6, additional cash inflows in

1. NPV

At r1 = 12%, NPV is positive => NPV1

2. Calculate internal rate of return

Find r2 = 18%, NPV2 is negative

3. Accrual accounting rate of return

Net initial investment= 94,000+4,000= 9

4. Based on average investment

5. DCF method
If DCF is used, purchase should be made
If performance is based on accounting m
is smaller than cost of capital of 12%. Th
You may be reluctant to make the purcha
 Cost of machine + working capital investment
= 94,000+4,000 = 98,000

years
additional cash inflows include disposal value = 9,000

NPV is positive => NPV1 = 10,960

ernal rate of return

NPV2 is negative

unting rate of return

stment= 94,000+4,000= 98,000

erage investment

purchase should be made as NPV >0

is based on accounting measure, ARR = 10.95%
cost of capital of 12%. The result of ARR is not consistent with NPV and IRR
uctant to make the purchase decision
Outlay = $495,000
Working capital investment
Project period = 9 years
Tax rate = 30%
Cost of capital = 14%

1. NPV
annual cash flow after tax = CF before tax*(1-tax rate) = $130,000*0.7 = $91,000 dòng tiền sau thuế
Annual depreciation = $495,000/9 = $55,000 thuế được tính trên lợi nhuận
Income tax saving from depreciation = $55,000*30% = $16,500 lợi nhuận giảm vì trừ đi khấu h
Net annual cash flow after tax = $91,000 + $16,500 = $107,500 tiết kiệm được thuế

2. Accrual accounting rate of return

Net initial investment = 495,000 + 5,000 = 500,000
Operating income after tax
Net increase in operating income 130000
Less: Depreciation expense 55000
Income before tax 75000
Income tax expense at 30% 22500
Net income 52500

3
Since the project generates positive NPV => the project can be accepted because
it generates additional cash flow for the firm.
If Liam is evaluated based on accounting income with his bonus depending on achieving an ARR
of 14%, he would not accept the project as ARR is only 10.5% <14%
Conflict can be resolved by evaluating Liam on how well ha can be achieve the CF forecast
rather than accounting income
dòng tiền sau thuế
thuế được tính trên lợi nhuận
lợi nhuận giảm vì trừ đi khấu hao
tiết kiệm được thuế

ng an ARR