An investment is acceptable if its irr

Faculty of Law and Management

FUNDAMENTALS OF FINANCE

Lecture 5: Investment Evaluation Techniques

Presented by: Dr Balasingham Balachandran Professor of Finance Department of Finance, La Trobe Business School

Investment Evaluation Techniques

2 These slides have been drafted by the La Trobe University School of Economics & Finance based on Berk (2011).

Topic Overview

 Introduction to capital budgeting and investment

evaluation

 Net Present Value (NPV)

 Internal Rate of Return (IRR)

 Payback Period (PP)

 Accounting Rate of Return (ARR)

 Choosing between projects when resources are

limited

These slides have been drafted by the Department of Finance, La Trobe Business School based on Berk (2014).

Investment Evaluation Techniques

Learning Objectives

 Understand alternative decision rules and their

drawbacks

 Choose between mutually exclusive investments

 Rank projects when a company’s resources are

limited so that it cannot take all positive- NPV

projects

3

Investment Evaluation Techniques

4

 The investment decision entails deciding which projects or investments

should be undertaken

 Companies need to use investment evaluation techniques to determine

the value of the projects available to them

 The final decision as to which projects a company should undertake is

known as ‘capital budgeting’

 In this topic we will apply a number of techniques to the valuation of

individual projects

Investment evaluation and capital budgeting

Investment Evaluation Techniques

5

 When a corporation allocates funds to long-term investment projects, the outlay is made in the expectation of generating future cash flows

 In making the decision to invest in a project, the key consideration is whether or not the proposal provides an adequate return to investors

 The process used to select projects to invest – capital budgeting – is essentially a process to decide on the optimum use of scarce resources

Investment evaluation and capital budgeting

Investment Evaluation Techniques

6

There are three fundamental stages in making capital budgeting

decisions:  Stage 1 is the forecasting of costs and benefits associated with a project – the most

important being the financial ones

 Stage 2 involves the application of an investment evaluation technique to decide

whether a project is acceptable, or optimal amongst alternative projects

 Stage 3 is the ultimate decision to accept or reject a project

The capital budgeting process

Investment Evaluation Techniques

7

 In this lecture we will discuss the four best-known

investment evaluation techniques

 Two of these are based on the discounted cash flow

(DCF) model:  Net present value (NPV)

 Internal rate of return (IRR)

 The other two are accounting-based techniques:  Payback

 (Average) accounting rate of return (ARR)

Investment evaluation techniques

Investment Evaluation Techniques

8

 In evaluating projects, it is important to keep in mind the

type of projects being considered

 Projects can be:

 Independent

 Mutually exclusive

 Independent projects can be evaluated separately, and

as long as there are sufficient funds are available, a

company should invest in all acceptable independent

projects

Types of projects

Investment Evaluation Techniques

9

 If two or more projects are mutually exclusive, a company can

only choose one of them – the one that is ranked highest by

the evaluation technique being used

 Projects could be neither mutually exclusive nor independent,

in the sense that accepting one project affects the cash flows

of another

 Project evaluation in this case is complex and largely beyond

the scope of this subject

Types of projects

Investment Evaluation Techniques

10

 This technique involves calculating the present value of all future cash

inflows and cash outflows that will result from undertaking a project

 These positive and negative present values are then netted off

against one another to determine the net present value of the project

 The firm should accept all positive-NPV projects and reject negative-

NPV projects, because NPV measures the increase in value from the

project

Net Present Value (NPV)

Investment Evaluation Techniques

11

 If the NPV of a project is zero, the firm would be indifferent between

undertaking the project or paying the available cash back to

shareholders

 This is because zero NPV indicates that the project yields the same

future cash that the investors could obtain by investing themselves

 A project is acceptable if the accumulated cash flow at the end of the

project exceeds the cash flow that investors could have generated

Net Present Value (NPV)

Investment Evaluation Techniques

12

 Most firms measure values in terms of net present value–that is, in

terms of cash today.

The NPV decision rule

NPV = PV (Benefits) – PV (Costs)

(Eq. 8.1)

Investment Evaluation Techniques

13

where:

CFt = cash flow generated by the project in year t

r = the opportunity cost of capital

CF0 = the cost of the project (initial cash flow, if any)

n = the life of the project in years

The net present value of a project is calculated as

follows:

Net Present Value (NPV)

  0

1

NPV 1

n t

t t

CF CF

r  

 

Investment Evaluation Techniques

Using the NPV Rule

 Consider an investment project that requires to built a new fertiliser

plant at a cost of $81.6 million.

 Estimated return on the new fertiliser will be $28 million after the first

year, and lasting four years as shown by the timeline below:

14

Month: 0 1 2 3

4

Cash Flow: ($81.60) $28 $28 $28 $28

Cost of capital is10%

Investment Evaluation Techniques

 Therefore, given a discount rate r, the NPV of this project is:

 If we replace r with the estimated cost of capital of 10%, we get an NPV of

$7.2 million, which is positive.

 In this case, the project’s benefits outweigh the costs by $7.2 million and will

increase the value of the firm.

15

Using the NPV Rule

NPV = -81.6 + 28

+ 28

+ 28

+ 28

1+r (1+r)2 (1+r)3 (1+r)4

Investment Evaluation Techniques

 The NPV of the project depends on the appropriate cost of capital.

 It is helpful to calculate an NPV profile, which graphs the project’s NPV over

a range of discount rates.

16

NPV Profile

 Based on this data the NPV

is positive only when the

discount rates are less than 14%.

Investment Evaluation Techniques

17

Net Present Value (NPV)

Example:

A company is considering whether to outlay $500,000 for a machine

that will generate $150,000 p.a. over the next 5 years. What is the

NPV of this project, given an opportunity cost of capital of 10%?

Investment Evaluation Techniques

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 The strengths of the NPV technique are:  It always ensures the selection of projects that maximise the wealth of

shareholders

 It takes into account the time value of money

 It considers all cash flows expected to be generated by a project

 Two possible weaknesses are:  It requires extensive forecasts of the costs and benefits of a project,

which can be problematic

 The concept is difficult for non-finance-trained managers to understand

Net Present Value (NPV)

Investment Evaluation Techniques

Payback Period

• Payback period is the amount of time required for an investment to generate cash flows to recover its initial cost.

• Steps in estimating the payback period are:  Estimate the cash flows.

 Accumulate the future cash flows until they equal the initial investment.

 Work out how long this takes to happen.

• An investment is acceptable if its calculated payback is less than some prescribed number of years.

Investment Evaluation Techniques

20

 The payback is given by:

The payback technique

year before full recovery

cost to be recovered at start of year

cash flow during year

Payback 



Investment Evaluation Techniques

21

The payback technique

Example:

Calculate the payback period for the following project.

Year 0 1 2 3 4 5 6

Project A -1000 100 200 800 100 100 100

Investment Evaluation Techniques

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The payback technique

Example:

Calculate the payback period for the following project.

Year 0 1 2 3 4 5 6

Project A -1000 100 200 800 100 100 100

Cum NCF

Investment Evaluation Techniques

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The payback technique

Example:

Calculate the payback period for the following project.

Year 0 1 2 3 4 5 6

Project A -1000 100 200 800 100 100 100

Cum NCF -900

Investment Evaluation Techniques

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The payback technique

Example:

Calculate the payback period for the following project.

Year 0 1 2 3 4 5 6

Project A -1000 100 200 800 100 100 100

Cum NCF -900 -700

Investment Evaluation Techniques

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The payback technique

Example:

Calculate the payback period for the following project.

Year 0 1 2 3 4 5 6

Project A -1000 100 200 800 100 100 100

Cum NCF -900 -700 100

Investment Evaluation Techniques

26

The payback technique

Example:

Calculate the payback period for the following project.

Year 0 1 2 3 4 5 6 Payback

Project A -1000 100 200 800 100 100 100

Cum NCF -900 -700 100 200 300 400 2.88 yrs

At the end of the third year, the sign of the cumulative net cash flow

has changed from negative to positive. Therefore the payback

occurred during the third year. If we assume the year 3 cash flow

is earned evenly

during year 3, the

payback period is: years88.2

800

700 2 

A Payb ack

Investment Evaluation Techniques

27

Example

Cash flows for projects A to F are given

below:

Year A B C D E F 0 -900 -900 -900 -900 -900 -900

1 300 300 100 600 600 300

2 300 300 200 200 200 300

3 300 300 600 100 100 300

4 - 300 - - 100

Calculate the payback period for these projects A-F.

Which one is the best investment?

Investment Evaluation Techniques

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Example

Cash flows for projects I and D are given

below:

Year Project I Project D

0 (100) (100)

1 10 70

2 60 50

3 80 20

Investment Evaluation Techniques

29

Example continued

The significant cash flows occur in later years!

10 80 60

0 1 2 3

– 100

=

Cumulative – 100 – 90 – 30 50

PBPI 2 + 30/80 = 2.375

years

0

2.375

Project I

30

Investment Evaluation Techniques

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Example Continued

The significant cash flows come early!

70 20 50

0 1 2 3

– 100

Cumulative – 100 – 30 20 40

PBPD 1 + 30/50 = 1.6 years

0

1.6

=

Project D

30

Investment Evaluation Techniques

Decision Criteria Test - Payback

• Does the payback rule account for the time value of money?

• Does the payback rule account for the risk of the cash flows?

• Does the payback rule provide an indication about the increase in value?

• Should we consider the payback rule for our primary decision rule?

Investment Evaluation Techniques

Evaluation of Payback Period

 Advantages:

 Easy to understand.

 Adjusts for uncertainty of later cash flows.

 Disadvantages:

 Time value of money and risk ignored.

 Ignores cash flows beyond the cut-off date.

 Biased against long-term projects or Lacks a decision criterion grounded in

economics.

 Arbitrary determination of acceptable payback period.

Investment Evaluation Techniques

33

 The discounted payback period is similar to the normal payback period, except that the cash flows are discounted to present value

 The discounted payback period is the time taken to recover the outlay from discounted cash flows

 This takes account of the time value of money (for cash flows within the payback period) but does not allow for risk, ignores cash flows after the pay- back period and is subject to an arbitrary cut-off

The discounted payback technique

Investment Evaluation Techniques

34

The discounted payback technique

Example:

Calculate the discounted payback period for the following project

(discounting cash flows at a required rate of return of 10%).

Year 0 1 2 3 4 5 6

Project A -1000 100 200 800 100 100 100

Disc CF

Cum NCF

Investment Evaluation Techniques

35

The discounted payback technique

Example:

Calculate the discounted payback period for the following project

(discounting cash flows at a required rate of return of 10%).

Year 0 1 2 3 4 5 6

Project A -1000 100 200 800 100 100 100

Disc CF -1000

Cum NCF

Investment Evaluation Techniques

36

The discounted payback technique

Example:

Calculate the discounted payback period for the following project

(discounting cash flows at a required rate of return of 10%).

Year 0 1 2 3 4 5 6

Project A -1000 100 200 800 100 100 100

Disc CF -1000

Cum NCF

1.1

100

Investment Evaluation Techniques

37

The discounted payback technique

Example:

Calculate the discounted payback period for the following project

(discounting cash flows at a required rate of return of 10%).

Year 0 1 2 3 4 5 6

Project A -1000 100 200 800 100 100 100

Disc CF -1000

= 91

Cum NCF

1.1

100

Investment Evaluation Techniques

38

The discounted payback technique

Example:

Calculate the discounted payback period for the following project

(discounting cash flows at a required rate of return of 10%).

Year 0 1 2 3 4 5 6

Project A -1000 100 200 800 100 100 100

Disc CF -1000

= 91

Cum NCF

1.1

100 2

1.1

200

Investment Evaluation Techniques

39

The discounted payback technique

Example:

Calculate the discounted payback period for the following project

(discounting cash flows at a required rate of return of 10%).

Year 0 1 2 3 4 5 6

Project A -1000 100 200 800 100 100 100

Disc CF -1000

= 91

= 165

Cum NCF

1.1

100 2

1.1

200

Investment Evaluation Techniques

40

The discounted payback technique

Example:

Calculate the discounted payback period for the following project

(discounting cash flows at a required rate of return of 10%).

Year 0 1 2 3 4 5 6

Project A -1000 100 200 800 100 100 100

Disc CF -1000

= 91

= 165

= 601

= 68

= 62

=56

Cum NCF

1.1

100 2

1.1

200 3

1.1

800 4

1.1

100 5

1.1

100 6

1.1

100

Investment Evaluation Techniques

41

The discounted payback technique

Example:

Calculate the discounted payback period for the following project

(discounting cash flows at a required rate of return of 10%).

Year 0 1 2 3 4 5 6

Project A -1000 100 200 800 100 100 100

Disc CF -1000

= 91

= 165

= 601

= 68

= 62

=56

Cum NCF -909

1.1

100 2

1.1

200 3

1.1

800 4

1.1

100 5

1.1

100 6

1.1

100

Investment Evaluation Techniques

42

The discounted payback technique

Example:

Calculate the discounted payback period for the following project

(discounting cash flows at a required rate of return of 10%).

Year 0 1 2 3 4 5 6 DPB

Project A -1000 100 200 800 100 100 100

Disc CF -1000

= 91

= 165

= 601

= 68

= 62

=56

Cum NCF -909 -744 -143 -74 -12 44 5.22 yrs

years22.5 56

12 5 

A Payb ackDisc

1.1

100 2

1.1

200 3

1.1

800 4

1.1

100 5

1.1

100 6

1.1

100

Investment Evaluation Techniques

Decision Criteria Test – Discounted Payback

• Does the discounted payback rule account for the time value of money?

• Does the discounted payback rule account for the risk of the cash flows?

• Does the discounted payback rule provide an indication about the increase in value?

• Should we consider the discounted payback rule for our primary decision rule?

Investment Evaluation Techniques

Evaluation of Discounted Payback

Advantages

 - Includes time value of money

 - Easy to understand

- Does not accept negative NPV

investments

Disadvantages

- May reject positive NPV investments

- Arbitrary determination of acceptable

payback period

- Ignores cash flows beyond the cut-off

date

- Biased against long-term investments.

Investment Evaluation Techniques

45

 The ARR is the percentage return on invested physical capital, and is based on accounting income and historical cost asset figures

 The ARR is given by:

Average Accounting Rate of Return (ARR)

 The ARR is compared with a predetermined ARR target, or “cut- off” rate, to determine whether to proceed with the project

capital invested average

income average ARR

Investment Evaluation Techniques

46

There are four stages in calculating the ARR:  Step 1:The average income over the life of the asset is estimated (Note that

“income” takes into account not only cash but non-cash items such as depreciation

 Step 2: The average net investment (after depreciation) is estimated

 Step 3: The ARR is found using the equation

 Step 4: If the ARR is greater than target return, the project should be accepted

Average Accounting Rate of Return (ARR)

Investment Evaluation Techniques

47

Average Accounting Rate of Return (ARR) Example: Step 1

Calculate the ARR for a 2-

year project involving a

machine that costs $100m

and will yield cash flows of

$53m & $65m in years 1 &

2.

The machine is to be

depreciated on a straight-

line basis, and the

corporate tax rate is 30%.

Calculate average net income

Year 1 2

Cash flow

Less depreciation

Taxable income

Less tax (30%)

Net income

Investment Evaluation Techniques

48

Average Accounting Rate of Return (ARR)

Example: Step 1

Calculate the ARR for a 2-

year project involving a

machine that costs $100m

and will yield cash flows

of $53m & $65m in years

1 & 2.

The machine is to be

depreciated on a straight-

line basis, and the

corporate tax rate is 30%.

Calculate average net income

Year 1 2

Cash flow 53 65

Less depreciation

Taxable income

Less tax (30%)

Net income

Investment Evaluation Techniques

68

Average Accounting Rate of Return (ARR)

Example: Step 1

Calculate the ARR for a 2-

year project involving a

machine that costs $100m

and will yield cash flows

of $53m & $65m in years

1 & 2.

The machine is to be

depreciated on a straight-

line basis, and the

corporate tax rate is 30%.

Calculate average net income

Year 1 2

Cash flow 53 65

Less depreciation 50 50

Taxable income

Less tax (30%)

Net income

Investment Evaluation Techniques

50

Average Accounting Rate of Return (ARR)

Example: Step 1

Calculate the ARR for a 2-

year project involving a

machine that costs $100m

and will yield cash flows

of $53m & $65m in years

1 & 2.

The machine is to be

depreciated on a straight-

line basis, and the

corporate tax rate is 30%.

Calculate average net income

Year 1 2

Cash flow 53 65

Less depreciation 50 50

Taxable income 3 15

Less tax (30%)

Net income

Investment Evaluation Techniques

51

Average Accounting Rate of Return (ARR)

Example: Step 1

Calculate the ARR for a 2-

year project involving a

machine that costs $100m

and will yield cash flows

of $53m & $65m in years

1 & 2.

The machine is to be

depreciated on a straight-

line basis, and the

corporate tax rate is 30%.

Calculate average net income

Year 1 2

Cash flow 53 65

Less depreciation 50 50

Taxable income 3 15

Less tax (30%) 1 5

Net income

Investment Evaluation Techniques

52

Average Accounting Rate of Return (ARR)

Example: Step 1

Calculate the ARR for a 2-

year project involving a

machine that costs $100m

and will yield cash flows

of $53m & $65m in years

1 & 2.

The machine is to be

depreciated on a straight-

line basis, and the

corporate tax rate is 30%.

Calculate average net income

Year 1 2

Cash flow 53 65

Less depreciation 50 50

Taxable income 3 15

Less tax (30%) 1 5

Net income 2 10

Investment Evaluation Techniques

53

Average Accounting Rate of Return (ARR)

Example: Step 1

Calculate the ARR for a 2-

year project involving a

machine that costs $100m

and will yield cash flows

of $53m & $65m in years

1 & 2.

The machine is to be

depreciated on a straight-

line basis, and the

corporate tax rate is 30%.

Calculate average net income

Year 1 2

Cash flow 53 65

Less depreciation 50 50

Taxable income 3 15

Less tax (30%) 1 5

Net income 2 10

Average = (2 + 10) / 2 = 6

Investment Evaluation Techniques

54

Average Accounting Rate of Return (ARR)

Example: Step 2

Calculate the ARR for a 2-

year project involving a

machine that costs $100m

and will yield cash flows

of $53m & $65m in years

1 & 2.

The machine is to be

depreciated on a straight-

line basis, and the

corporate tax rate is 30%.

Calculate average investment

Year 0 1 2

Machine cost

Less accum.

depreciation

Investment

Investment Evaluation Techniques

55

Average Accounting Rate of Return (ARR)

Example: Step 2

Calculate the ARR for a 2-

year project involving a

machine that costs $100m

and will yield cash flows

of $53m & $65m in years

1 & 2.

The machine is to be

depreciated on a straight-

line basis, and the

corporate tax rate is 30%.

Calculate average investment

Year 0 1 2

Machine cost 100 100 100

Less accum.

depreciation

Investment

Investment Evaluation Techniques

56

Average Accounting Rate of Return (ARR)

Example: Step 2

Calculate the ARR for a 2-

year project involving a

machine that costs $100m

and will yield cash flows

of $53m & $65m in years

1 & 2.

The machine is to be

depreciated on a straight-

line basis, and the

corporate tax rate is 30%.

Calculate average investment

Year 0 1 2

Machine cost 100 100 100

Less accum.

depreciation

0

Investment

Investment Evaluation Techniques

57

Average Accounting Rate of Return (ARR)

Example: Step 2

Calculate the ARR for a 2-

year project involving a

machine that costs $100m

and will yield cash flows

of $53m & $65m in years

1 & 2.

The machine is to be

depreciated on a straight-

line basis, and the

corporate tax rate is 30%.

Calculate average investment

Year 0 1 2

Machine cost 100 100 100

Less accum.

depreciation

0 50

Investment

Investment Evaluation Techniques

58

Average Accounting Rate of Return (ARR)

Example: Step 2

Calculate the ARR for a 2-

year project involving a

machine that costs $100m

and will yield cash flows

of $53m & $65m in years

1 & 2.

The machine is to be

depreciated on a straight-

line basis, and the

corporate tax rate is 30%.

Calculate average investment

Year 0 1 2

Machine cost 100 100 100

Less accum.

depreciation

0 50 100

Investment

Investment Evaluation Techniques

59

Average Accounting Rate of Return (ARR)

Example: Step 2

Calculate the ARR for a 2-

year project involving a

machine that costs $100m

and will yield cash flows

of $53m & $65m in years

1 & 2.

The machine is to be

depreciated on a straight-

line basis, and the

corporate tax rate is 30%.

Calculate average investment

Year 0 1 2

Machine cost 100 100 100

Less accum.

depreciation

0 50 100

Investment 100 50 0

Investment Evaluation Techniques

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Average Accounting Rate of Return (ARR)

Example: Step 2

Calculate the ARR for a 2-

year project involving a

machine that costs $100m

and will yield cash flows

of $53m & $65m in years

1 & 2.

The machine is to be

depreciated on a straight-

line basis, and the

corporate tax rate is 30%.

Calculate average investment

Year 0 1 2

Machine cost 100 100 100

Less accum.

depreciation

0 50 100

Investment 100 50 0

Average investment =

(100 + 50 + 0) / 3 = 50

Investment Evaluation Techniques

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Average Accounting Rate of Return (ARR)

Example: Step 3

Calculate the ARR for a 2-

year project involving a

machine that costs $100m

and will yield cash flows

of $53m & $65m in years

1 & 2.

The machine is to be

depreciated on a straight-

line basis, and the

corporate tax rate is 30%.

Calculate the ARR

Step 4

Compare the ARR to a target or

“cut-off” rate to accept or reject

Investment Evaluation Techniques

62

Average Accounting Rate of Return (ARR)

Example: Step 3

Calculate the ARR for a 2-

year project involving a

machine that costs $100m

and will yield cash flows

of $53m & $65m in years

1 & 2.

The machine is to be

depreciated on a straight-

line basis, and the

corporate tax rate is 30%.

Calculate the ARR

Step 4

Compare the ARR to a target or

“cut-off” rate to accept or reject

%12 50

6

capital invested Avg

income Avg



Investment Evaluation Techniques

63

Average Accounting Rate of Return (ARR)

Example: Step 3

Calculate the ARR for a 2-

year project involving a

machine that costs $100m

and will yield cash flows

of $53m & $65m in years

1 & 2.

The machine is to be

depreciated on a straight-

line basis, and the

corporate tax rate is 30%.

Calculate the ARR

Step 4

Compare the ARR to a target or

“cut-off” rate to accept or reject

%12 50

6

capital invested Avg

income Avg



Investment Evaluation Techniques

64

Average Accounting Rate of Return (ARR)

Example: Step 3

Calculate the ARR for a 2-

year project involving a

machine that costs $100m

and will yield cash flows

of $53m & $65m in years

1 & 2.

The machine is to be

depreciated on a straight-

line basis, and the

corporate tax rate is 30%.

Calculate the ARR

Step 4

Compare the ARR to a target or

“cut-off” rate to accept or reject

%12 50

6

capital invested Avg

income Avg



Investment Evaluation Techniques

65

The ARR technique has a number of disadvantages,

including the fact that it:

 Is based on accounting figures, which are not necessarily related to

cash flows and are based on accounting techniques that may vary

from company to company

 Ignores the time value of money

 Requires an arbitrary target or “cut-off” rate, but there is little

theoretical or other guidance in setting an appropriate target ARR

Average Accounting Rate of Return (ARR)

Investment Evaluation Techniques

66

 The IRR technique is also based on a DCF model, but focuses on the

rate of return in the DCF equation rather than the NPV

 The IRR is defined as the discount rate that equates the present value

of a project’s cash inflows with the present value of its cash outflows

 This is the equivalent of saying that the IRR is the discount rate at

which the NPV of the project is equal to 0

Internal Rate of Return (IRR)

Investment Evaluation Techniques

67

Stated formally:

Internal Rate of Return (IRR)

  0

1

0 1

n t

t t

F CF

r  

 

where:

Ft = cash flow generated by the project in year t

C0 = the cost of the project (initial cash flow, if any)

n = the life of the project in years

r = the internal rate of return on the project

Investment Evaluation Techniques

68

 The unknown variable (r) can be solved using a financial calculator or

by trial-and-error

 The decision rule is to accept a project if its IRR is greater than the

cost of capital and reject it if its IRR is less than the cost of capital

 It is clear from a comparison of the NPV and IRR equations that these

methods use the same framework and inputs, so they should result in

the same accept/reject decision

Internal Rate of Return (IRR)

Investment Evaluation Techniques

69

Internal Rate of Return (IRR)

Example:

Apply the IRR rule to a project that costs $100 million and yields

$106 million in one year when the opportunity cost of capital is

7%.

Investment Evaluation Techniques

70

Internal Rate of Return (IRR)

Example:

Apply the IRR rule to a project that costs $100 million and yields

$106 million in one year when the opportunity cost of capital is

7%.

  0

1

0 1

106 0 100

1

6%

n t

t t

CF CF

irr

m m

r

r



  

   

 



Investment Evaluation Techniques

71

Internal Rate of Return (IRR)

Example:

Apply the IRR rule to a project that costs $100 million and yields

$106 million in one year when the opportunity cost of capital is