FORMULAS

FINMAN2 V24 K31 K32 AY 2012-2013, Term 1

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Chapter 11 Titman 11ed/ 9 Keown 10ed: Capital-Budgeting Decision Criteria Methods for evaluating projects Present-value methods A. NPV =
t =1 n

FCFt (1 + k) t

- IO , accept if NPV 0 reject if NPV < 0 PV of Costs PVIFA

B. Equivalent Annual Cost (EAC) =

n

C. Profitability Index (PI) =

t =1

(1 + k) t , accept if PI 1.0 reject if PI < 1.0 IO

FCFt

D) Internal rate of return (IRR) IO =

t =1

FCFt (1 + IRR) t

accept if IRR required rate of return reject if IRR < required rate of return

E) Modified IRR (MIRR)

1. Take all the annual free tax cash inflows, ACIFt's, and find their future value at the end of the project's life compounded at the required rate of return - this is called the terminal value or TV. 2. All cash outflows, ACOFt, are then discounted back to present at the required rate of return. 3. MIRR: the discount rate that equates the PV of the cash outflows with the PV of the terminal value, i.e., that makes PVoutflows = PVinflows 4. If the MIRR is greater than or equal to the required rate of return, the project should be

accepted.
t =0

ACOFt (1 + k) t ACOFt (1 + k) t

t =0

ACIFt (1 + k) n t (1 + MIRR) n

t =0

1 (1 + MIRR) n

t=0

ACIFt (1 + k) n t

Look for PVIF, and get the corresponding % = MIRR.

FORMULAS
Payback period method A) Payback period

FINMAN2 V24 K31 K32 AY 2012-2013, Term 1

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a. Equal payments = $IO / $CF per year b. Payback Period = - $IO + $CF 1= $Balance 1 + $CF 2 = $Balance 2 + $CF3
=$Balance n + $CF n= until $Balance becomes positive PB = Year n-1 or Year before $Balance becomes positive + $Balance n / $CFn B) Discounted Payback Period = number of years needed to recover the initial cash outlay from the discounted free cash flows