Managerial Accounting

Presented To: Presented By: Sir Suleman Rehman Ali Naveed Arab (14659) Saad Pasha Wali Haider

Topic Of Presentation Net Present Value & Internal Rate Of Return

Net Present Value

Net present value (NPV) or net present worth (NPW) of a time series of cash flows, both incoming and outgoing, is defined as the sum of the present values (PVs) of the individual cash flows of the same entity. In the case when all future cash flows are incoming (such as coupons and principal of a bond) and the only outflow of cash is the purchase price, the NPV is simply the PV of future cash flows minus the purchase price (which is its own PV). NPV is a central tool in discounted cash flow (DCF) analysis and is a standard method for using the time value of money to appraise long-term projects.

Calculation Of NPV
Each cash inflow/outflow is discounted back to its present value (PV). Then they are summed. Therefore NPV is the sum of all terms,

Where

t- the time of the cash flow i- the discount rate (the rate of return that could be earned on an investment in the financial markets with similar risk.); the opportunity cost of capital

Rt- the net cash flow i.e. cash inflow cash outflow, at time t .
Ro- is commonly placed to the left of the sum to emphasize its role as (minus) the investment

Calculation Of NPV
Given the (period, cash flow) pairs (t, Rt) where N is the total number of periods, the net present value NPV is given by:

NPV Decision Making

NPV is an indicator of how much value an investment or project adds to the firm. With a particular project; If Rt is a positive value, the project is in the status of positive cash inflow in the time of t. If Rt is a negative value, the project is in the status of discounted cash outflow in the time of t.

In financial theory, if there is a choice between two mutually exclusive alternatives, the one yielding the higher NPV should be selected.

Example

Example

Example

Internal Rate Of Return

Internal rate of return (IRR) is the interest rate at which the net present value of all the cash flows (both positive and negative) from a project or investment equal zero. Internal rate of return is used to evaluate the attractiveness of a project or investment. If the IRR of a new project exceeds a companys required rate of return, that project is desirable. If IRR falls below the required rate of return, the project should be rejected.

Calculation Of Internal Rate Of Return

IRR Decision Making

If a project has Higher IRR than the required rate of return it should be considered. Among Mutually Exclusive projects one which has the highest IRR should be considered. If the results of the NPV & IRR are contradictory than the project with a higher NPV should be considered because of higher returns in absolute Monetary results.