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Payback Period
Discounted Payback Period
Net Present Value (NPV)
Profitability Index (PI)
Internal Rate of Return (IRR)
Modified Internal Rate of Return (MIRR)
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Advantages
Includes time value of
money
Easy to understand
Biased towards liquidity
Disadvantages
Requires an arbitrary
cutoff point
Ignores cash flows
beyond the cutoff point
Biased against long-term
projects, such as R&D
and new products
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Decision criteria:
If the NPV is greater than $0, the firm will earn a return
greater than its cost of capital. Such action should
increase the market value of the firm, and therefore the
wealth of its owners by an amount equal to the NPV.
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Decision criteria:
If the IRR is greater than the cost of capital, accept the
project.
If the IRR is less than the cost of capital, reject the
project.
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Comparing
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Exceptions:
Non-conventional cash flows cash flow signs
change more than once
Mutually exclusive projects
Initial investments (i.e. size) are substantially
different
Timing of cash flows is substantially different
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Project A
year cash flow
0
(135,000)
1
60,000
2
60,000
3
60,000
required return = 12%
IRR = 15.89%
NPV = RM9,110
PI = 1.07
Project B
year cash flow
0
(30,000)
1
15,000
2
15,000
3
15,000
required return = 12%
IRR = 23.38%
NPV = RM6,027
PI = 1.20
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Project A
year cash flow
0
(48,000)
1
1,200
2
2,400
3
39,000
4
42,000
required return = 12%
Project B
year cash flow
0
(46,500)
1
36,500
2
24,000
3
2,400
4
2,400
required return = 12%
IRR = 18.10%
NPV = RM9,436
PI = 1.20
IRR = 25.51%
NPV =RM8,455
PI = 1.18
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If you have more than one IRR, which one do you use
to make your decision?
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Period
Project A Project B
-500
-400
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325
200
IRR
19.43%
22.17%
NPV
64.05
60.74
Which project
should you accept
and why?
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IRR
MIRR
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(90,000) 132,000
100,000
(150,000)
0
1
2
3
RM90,000
RM98,627
RM174,570
RM115,000
RM188,627 (1 + MIRR)3 = RM 289,570
MIRR = 15.36% (> 15 %.... ACCEPT)
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Machine 1
(45,000)
20,000
20,000
20,000
Machine 2
(45,000)
12,000
12,000
12,000
12,000
12,000
12,000
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NPV1
= RM1,433
NPV2 = RM1,664
So,
NO!
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Machine 1:
PV = EAA 1 (PVIFA 3, 14)
RM1433 = EAA 1 (2.3216)
EAA 1 = RM617
Machine 2:
PV = EAA 2 (PVIFA 6, 14)
RM1664 = EAA 2 (3.8887)
EAA 2 = RM428
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EAA1 = RM617
EAA2 = RM428
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Machine 1
RM1433
0
RM1433
1
Machine 2
RM1664
0
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Then find the total NPV over the life of the project
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