Scribd
Upload
28 views25 pages

Weighing Net Present Value and Other Capital Budgeting Criteria

Uploaded by

Rabie Haroun
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as PPTX, PDF, TXT or read online on Scribd
28 views25 pages

Weighing Net Present Value and Other Capital Budgeting Criteria

Uploaded by

Rabie Haroun
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as PPTX, PDF, TXT or read online on Scribd
You are on page 1/ 25

CHAPTER 13

WEIGHING NET PRESENT VALUE


AND OTHER CAPITAL BUDGETING
CRITERIA
M: Finance 3rd Edition
Cornett, Adair, and Nofsinger
Copyright © 2016 by McGraw-Hill Education. All rights reserved.
Capital Budgeting Techniques

• Project evaluation methods


• Net Present Value (NPV) is preferred method
• Internal Rate of Return (IRR)
• Payback (PB)
Capital Budgeting Techniques

• Project evaluation methods


• Discounted Payback (DPB)
• Modified Internal Rate of Return (MIRR)
• Profitability Index (PI)
Choice of Decision Statistic Format

• Financial decisions primarily driven by


• Currency
• Time
• Rate of return
Capital Budgeting Decisions

• Deciding on single project acceptance


• Compute statistic
• Compare with benchmark
Capital Budgeting Decisions

• Deciding on mutually exclusive


projects
• Compute statistic
• Conduct “runoff” between mutually exclusive
projects
• Compare winning project with benchmark
Payback and Discounted Payback

• Payback statistic
• Break-even calculation for costs of financing
new project
Payback Benchmark

• Benchmark can vary


• Based on relevant external constraint
Discounted Payback Statistic

• Compensates for time value of money


Discounted Payback Benchmark

• Not recommended to compare


Discounted Payback Benchmark
(DPB) with Payback Benchmark (PB)
• DPB will be larger than regular PB
Payback and Discounted Payback Strengths

• Strengths
• Easy to calculate
• Intuitive

• Weaknesses
• Accept/reject benchmarks are arbitrary
• Ignore cash flows after the payback period
• PB ignores the time value of money
Net Present Value
• Measures value created by the project
NPV Benchmark
• Includes all cash flows – both inflows
and outflows
NPV Strengths and Weaknesses
• Strengths
• Not a ratio
• Works well for both independent projects and
mutually-exclusive projects
• Weaknesses
• Managers can misinterpret the results
• May compare NPV to cost even though cost
already incorporated into the NPV
IRR and Modified Internal Rate of Return
• IRR most popular technique
• IRR gives same accept/reject decision
as NPV when used with normal cash-
flow projects
NPV vs. IRR
• NPV and IRR are closely related
Internal Rate of Return Statistic
• To calculate IRR, solve the NPV
formula for interest rate that makes
NPV equal zero
IRR Benchmark
• Calculate the IRR and compare cost of
capital (investors’ required return) to
see if the project is acceptable
Problems with IRR
• IRR will be consistent with NPV as
long as project
• Has normal cash flows
• Is independent of other projects
IRR and NPV with Non-Normal Cash Flows

• Recommended not to use IRR with


non-normal cash flows
• Modified Internal Rate of Return is
better
Differing Reinvestment Rate Assumptions
• NPV and IRR assumptions differ re:
reinvestment of cash flows
• IRR assumes reinvestment in another project
with same earning power
• NPV assumes investment are reinvested at
cost of capital
• NPV’s reinvestment rate assumption is
considered superior to IRR’s
Modified Internal Rate of Return
• “Fixes” IRR reinvestment rate problem
• Uses cost of capital to move cash
flows
• MIRR not appropriate for mutually
exclusive projects
IRR, MIRR, NPV Mutually Exclusive Projects

• Rate-based statistics cause problems


when project cash flows have
differences in
• Scale
• Timing
MIRR Strengths and Weakness
• Strengths
• Corrects IRR’s reinvestment rate assumption
• Fixes non-normal cash flows problem

• Weakness
• Does not correct IRR issues with choosing the
wrong mutually exclusive project for range of
rates
Profitability Index
• Based on NPV
• Use when firm has resource
constraints on capital available for new
projects

You might also like

pFad - Phonifier reborn

Pfad - The Proxy pFad of © 2024 Garber Painting. All rights reserved.

Note: This service is not intended for secure transactions such as banking, social media, email, or purchasing. Use at your own risk. We assume no liability whatsoever for broken pages.


Alternative Proxies:

Alternative Proxy

pFad Proxy

pFad v3 Proxy

pFad v4 Proxy