Introduction > Normal vs. Nonnormal CFs > Independent vs. mutually exclusive projects > Payback period > Discounted payback period > Calculating NPV > NPV profiles > IRR > NPV vs. IRR > MIRR > Multiple IRRs > Conclusion
3
Introduction > Normal vs. Nonnormal CFs > Independent vs. mutually exclusive projects > Payback period > Discounted payback period > Calculating NPV > NPV profiles > IRR > NPV vs. IRR > MIRR > Multiple IRRs > Conclusion
− 
Initial investments. 
− 
Subsequent cash inflows/ outflows. 
4
Introduction > Normal vs. Nonnormal CFs > Independent vs. mutually exclusive projects > Payback period > Discounted payback period > Calculating NPV > NPV profiles > IRR > NPV vs. IRR > MIRR > Multiple IRRs > Conclusion
5
Introduction > Normal vs. Nonnormal CFs > Independent vs. mutually exclusive projects > Payback period > Discounted payback period > Calculating NPV > NPV profiles > IRR > NPV vs. IRR > MIRR > Multiple IRRs > Conclusion
0 
1 
2 
3 
 
 
 
 
Project L 
100 
10 
60 
80 
Project S 
100 
70 
50 
20 
6
Introduction > Normal vs. Nonnormal CFs > Independent vs. mutually exclusive projects > Payback period > Discounted payback period > Calculating NPV > NPV profiles > IRR > NPV vs. IRR > MIRR > Multiple IRRs > Conclusion
7
Introduction > Normal vs. Nonnormal CFs > Independent vs. mutually exclusive projects > Payback period > Discounted payback period > Calculating NPV > NPV profiles > IRR > NPV vs. IRR > MIRR > Multiple IRRs > Conclusion
• 
Independent projects – if the cash flows of one are unaffected by the acceptance of the other. 

− 
Both projects can be accepted 

• 
Mutually exclusive projects – if one is accepted, the other would have to be rejected. 
8
Introduction > Normal vs. Nonnormal CFs > Independent vs. mutually exclusive projects > Payback period > Discounted payback period > Calculating NPV > NPV profiles > IRR > NPV vs. IRR > MIRR > Multiple IRRs > Conclusion
• 
Payback 

− 
Discounted payback 

• 
Net Present Value (NPV) 

• 
Internal Rate of Return (IRR) 
0 
1 
2 
3 
 
 
 
 
Project L 
100 
10 
60 
80 
Project S 
100 
70 
50 
20 
9
Introduction > Normal vs. Nonnormal CFs > Independent vs. mutually exclusive projects > Payback period > Discounted payback period > Calculating NPV > NPV profiles > IRR > NPV vs. IRR > MIRR > Multiple IRRs > Conclusion
• 
The number of years required to recover a project’s 
• 
cost, or “How long does it take to get our money back?” Calculated by adding project’s cash inflows to its 
10
Introduction > Normal vs. Nonnormal CFs > Independent vs. mutually exclusive projects > Payback period > Discounted payback period > Calculating NPV > NPV profiles > IRR > NPV vs. IRR > MIRR > Multiple IRRs > Conclusion
Payback _{L} 
= 
Payback _{S} 
= 
11
Introduction > Normal vs. Nonnormal CFs > Independent vs. mutually exclusive projects > Payback period > Discounted payback period > Calculating NPV > NPV profiles > IRR > NPV vs. IRR > MIRR > Multiple IRRs > Conclusion
• 
Weaknesses 

− 
Arbitrary benchmark. 

− 
Ignores the time value of money. 

− 
Ignores CFs occurring after the payback period. 

• 
Strengths 
− 
Easy to calculate and understand. 
− 
Provides an indication of a project’s risk and liquidity. 
12
Introduction > Normal vs. Nonnormal CFs > Independent vs. mutually exclusive projects > Payback period > Discounted payback period > Calculating NPV > NPV profiles > IRR > NPV vs. IRR > MIRR > Multiple IRRs > Conclusion
CF _{t} 
100 
10 
60 
80 
_{P}_{V} _{o}_{f} _{C}_{F} _{t} 
100 
9.09 
49.59 
60.11 
_{C}_{u}_{m}_{u}_{l}_{a}_{t}_{i}_{v}_{e} 
100 
90.91 
41.32 
18.79 
13
Introduction > Normal vs. Nonnormal CFs > Independent vs. mutually exclusive projects > Payback period > Discounted payback period > Calculating NPV > NPV profiles > IRR > NPV vs. IRR > MIRR > Multiple IRRs > Conclusion
• 
Normal cash flows versus nonnormal cash flows. 
• 
Independent versus mutually exclusive projects. 
• 
Payback period is the number of years it takes to 
14
Introduction > Normal vs. Nonnormal CFs > Independent vs. mutually exclusive projects > Payback period > Discounted payback period > Calculating NPV > NPV profiles > IRR > NPV vs. IRR > MIRR > Multiple IRRs > Conclusion
15
Introduction > Normal vs. Nonnormal CFs > Independent vs. mutually exclusive projects > Payback period > Discounted payback period > Calculating NPV > NPV profiles > IRR > NPV vs. IRR > MIRR > Multiple IRRs > Conclusion
NPV
N
t
0
CF
t
( 1
r )
t
CF
1
CF
2
CF
0
1
2
( 1 r )
( 1
r )
CF
N
( 1
r )
N
16
Introduction > Normal vs. Nonnormal CFs > Independent vs. mutually exclusive projects > Payback period > Discounted payback period > Calculating NPV > NPV profiles > IRR > NPV vs. IRR > MIRR > Multiple IRRs > Conclusion
17
Introduction > Normal vs. Nonnormal CFs > Independent vs. mutually exclusive projects > Payback period > Discounted payback period > Calculating NPV > NPV profiles > IRR > NPV vs. IRR > MIRR > Multiple IRRs > Conclusion
0 
1 
2 
3 
 
 
 
 
100 
70 
50 
20 
18
Introduction > Normal vs. Nonnormal CFs > Independent vs. mutually exclusive projects > Payback period > Discounted payback period > Calculating NPV > NPV profiles > IRR > NPV vs. IRR > MIRR > Multiple IRRs > Conclusion
• 
NPV indicates how much shareholders’ wealth will increase if project is taken up. 
– Higher NPV Higher increase in shareholders’ wealth. 

• 
NPV _{L} = $18.79 Shareholders’ wealth increases by $18.79 if Project L is accepted. 
• 
NPV _{S} = $19.98 Shareholders’ wealth increases by $19.98 if Project S is accepted. 
19
Introduction > Normal vs. Nonnormal CFs > Independent vs. mutually exclusive projects > Payback period > Discounted payback period > Calculating NPV > NPV profiles > IRR > NPV vs. IRR > MIRR > Multiple IRRs > Conclusion
• 
If projects are independent, accept if the project 
NPV > 0. 

– Accept both projects 

• 
If projects are mutually exclusive, accept projects with the highest positive NPV, those that add the most value. 
20
Introduction > Normal vs. Nonnormal CFs > Independent vs. mutually exclusive projects > Payback period > Discounted payback period > Calculating NPV > NPV profiles > IRR > NPV vs. IRR > MIRR > Multiple IRRs > Conclusion
Cost of Capital 
NPV _{L} 
NPV _{S} 
0 
$50 
$40 
5 
33 
29 
10 
19 
20 
15 
7 
12 
20 
(4) 
5 
21
Introduction > Normal vs. Nonnormal CFs > Independent vs. mutually exclusive projects > Payback period > Discounted payback period > Calculating NPV > NPV profiles > IRR > NPV vs. IRR > MIRR > Multiple IRRs > Conclusion
22
Introduction > Normal vs. Nonnormal CFs > Independent vs. mutually exclusive projects > Payback period > Discounted payback period > Calculating NPV > NPV profiles > IRR > NPV vs. IRR > MIRR > Multiple IRRs > Conclusion
N 
CF 

NPV 

t 

( 1 

r ) 
t 

t0 

• 
NPV = PV of inflows – PV of costs 

– NPV represents the net gain in shareholders’ wealth if a project is accepted. – Decision criteria: 





• 
NPV profile is a graphical representation of project 
23
Introduction > Normal vs. Nonnormal CFs > Independent vs. mutually exclusive projects > Payback period > Discounted payback period > Calculating NPV > NPV profiles > IRR > NPV vs. IRR > MIRR > Multiple IRRs > Conclusion
24
Introduction > Normal vs. Nonnormal CFs > Independent vs. mutually exclusive projects > Payback period > Discounted payback period > Calculating NPV > NPV profiles > IRR > NPV vs. IRR > MIRR > Multiple IRRs > Conclusion
25
Introduction > Normal vs. Nonnormal CFs > Independent vs. mutually exclusive projects > Payback period > Discounted payback period > Calculating NPV > NPV profiles > IRR > NPV vs. IRR > MIRR > Multiple IRRs > Conclusion
0 
1 
2 
3 

 
 
 
 

Project L 
100 
10 
60 
80 

10 


0 

100 

( 1 

IRR 


( 1 

IRR 


( 1 

IRR 

3 

• 
Solving for IRR with a financial calculator: 

– 
Enter CFs in CFLO register 

– 
Press IRR; IRR _{L} = 18.13% 

• 
Expected annual return for Project L is 18.13%. 
26
Introduction > Normal vs. Nonnormal CFs > Independent vs. mutually exclusive projects > Payback period > Discounted payback period > Calculating NPV > NPV profiles > IRR > NPV vs. IRR > MIRR > Multiple IRRs > Conclusion
0 
1 
2 
3 
 
 
 
 
100 
70 
50 
20 
27
Introduction > Normal vs. Nonnormal CFs > Independent vs. mutually exclusive projects > Payback period > Discounted payback period > Calculating NPV > NPV profiles > IRR > NPV vs. IRR > MIRR > Multiple IRRs > Conclusion
• 
If Projects S and L are independent, accept both projects as both IRR > cost of capital = 10%. 
• 
If Projects S and L are mutually exclusive, accept S, because IRR _{s} > IRR _{L} . 
28
Introduction > Normal vs. Nonnormal CFs > Independent vs. mutually exclusive projects > Payback period > Discounted payback period > Calculating NPV > NPV profiles > IRR > NPV vs. IRR > MIRR > Multiple IRRs > Conclusion
29
Introduction > Normal vs. Nonnormal CFs > Independent vs. mutually exclusive projects > Payback period > Discounted payback period > Calculating NPV > NPV profiles > IRR > NPV vs. IRR > MIRR > Multiple IRRs > Conclusion
• 
If projects are independent, the two methods always lead to the same accept/reject decisions. 
• 
If projects are mutually exclusive … 
30
Introduction > Normal vs. Nonnormal CFs > Independent vs. mutually exclusive projects > Payback period > Discounted payback period > Calculating NPV > NPV profiles > IRR > NPV vs. IRR > MIRR > Multiple IRRs > Conclusion
• 
The conflict between NPV and IRR arises due to timing differences in cash flows and differences in project size 
(scale). 

• 
When there are differences in cash flow timing or project 
scale, this implies that the firm will have different amounts to reinvest at various years depending on which of the mutually 

exclusive projects it accepts. 

• 
The rate at which the intermediate cash flows are reinvested at is a critical issue. 
31
Introduction > Normal vs. Nonnormal CFs > Independent vs. mutually exclusive projects > Payback period > Discounted payback period > Calculating NPV > NPV profiles > IRR > NPV vs. IRR > MIRR > Multiple IRRs > Conclusion
• 
NPV method assumes intermediate CFs are reinvested at the cost of capital. 
• 
IRR method assumes intermediate CFs are reinvested at IRR. 
• 
Assuming CFs are reinvested at the cost of capital is more realistic. 
32
Introduction > Normal vs. Nonnormal CFs > Independent vs. mutually exclusive projects > Payback period > Discounted payback period > Calculating NPV > NPV profiles > IRR > NPV vs. IRR > MIRR > Multiple IRRs > Conclusion
Project Large (L) 
Project Small (S) 

CF _{0} 
$100,000 
$1.00 
^{C}^{F} 110 
$50,000 
$0.60 
WACC 
10% 
10% 
NPV 

IRR 
33
Introduction > Normal vs. Nonnormal CFs > Independent vs. mutually exclusive projects > Payback period > Discounted payback period > Calculating NPV > NPV profiles > IRR > NPV vs. IRR > MIRR > Multiple IRRs > Conclusion
– 
Base decision on NPV criteria as NPV is superior. 
– 
NPV assumes reinvestment of intermediate CFs at the cost of capital which is more realistic. IRR assumes reinvestment at IRR rate. 
– 
NPV also gives a better indication of how much shareholders’ wealth is 
34
Introduction > Normal vs. Nonnormal CFs > Independent vs. mutually exclusive projects > Payback period > Discounted payback period > Calculating NPV > NPV profiles > IRR > NPV vs. IRR > MIRR > Multiple IRRs > Conclusion
35
Introduction > Normal vs. Nonnormal CFs > Independent vs. mutually exclusive projects > Payback period > Discounted payback period > Calculating NPV > NPV profiles > IRR > NPV vs. IRR > MIRR > Multiple IRRs > Conclusion
• 
Modify the IRR method such that intermediate cash 
flows are reinvested at the cost of capital. 

• 
MIRR (modified IRR) is the discount rate that causes 
36
Introduction > Normal vs. Nonnormal CFs > Independent vs. mutually exclusive projects > Payback period > Discounted payback period > Calculating NPV > NPV profiles > IRR > NPV vs. IRR > MIRR > Multiple IRRs > Conclusion
37
Introduction > Normal vs. Nonnormal CFs > Independent vs. mutually exclusive projects > Payback period > Discounted payback period > Calculating NPV > NPV profiles > IRR > NPV vs. IRR > MIRR > Multiple IRRs > Conclusion
38
Introduction > Normal vs. Nonnormal CFs > Independent vs. mutually exclusive projects > Payback period > Discounted payback period > Calculating NPV > NPV profiles > IRR > NPV vs. IRR > MIRR > Multiple IRRs > Conclusion
0 
1 
2 
3 
 
 
 
 
100 
70 
50 
20 
39
Introduction > Normal vs. Nonnormal CFs > Independent vs. mutually exclusive projects > Payback period > Discounted payback period > Calculating NPV > NPV profiles > IRR > NPV vs. IRR > MIRR > Multiple IRRs > Conclusion
• 
Managers like rate of return comparisons, and MIRR is better 

for this than IRR. 

– 
MIRR assumes reinvestment at cost of capital which is more realistic. 

– MIRR also avoids the multiple IRRs problem. 

• 
Is MIRR superior or equivalent to NPV? 

– 
When evaluating mutually exclusive projects, NPV is superior to MIRR but MIRR is superior to IRR 

– MIRR has the same problem with IRR when evaluating projects with different scale (Refer to the box titled “Why NPV is better than IRR” in section 12.3 of the textbook) 

• 
When evaluating independent projects, the three criteria 
40
Introduction > Normal vs. Nonnormal CFs > Independent vs. mutually exclusive projects > Payback period > Discounted payback period > Calculating NPV > NPV profiles > IRR > NPV vs. IRR > MIRR > Multiple IRRs > Conclusion
41
Introduction > Normal vs. Nonnormal CFs > Independent vs. mutually exclusive projects > Payback period > Discounted payback period > Calculating NPV > NPV profiles > IRR > NPV vs. IRR > MIRR > Multiple IRRs > Conclusion
42
Introduction > Normal vs. Nonnormal CFs > Independent vs. mutually exclusive projects > Payback period > Discounted payback period > Calculating NPV > NPV profiles > IRR > NPV vs. IRR > MIRR > Multiple IRRs > Conclusion
43
Introduction > Normal vs. Nonnormal CFs > Independent vs. mutually exclusive projects > Payback period > Discounted payback period > Calculating NPV > NPV profiles > IRR > NPV vs. IRR > MIRR > Multiple IRRs > Conclusion
• 
MIRR is a modified version of the IRR where intermediate cash flows are assumed to be 
reinvested at the cost of capital. 

– More realistic reinvestment assumption than IRR. – MIRR avoids the multiple IRRs problem. – Decision criteria is similar to IRR 

• 
NPV, IRR, and MIRR leads to same accept/reject 
• 
decision when choosing independent projects. When choosing mutually exclusive projects, conflicts can still arise between NPV and MIRR. 
44
Introduction > Normal vs. Nonnormal CFs > Independent vs. mutually exclusive projects > Payback period > Discounted payback period > Calculating NPV > NPV profiles > IRR > NPV vs. IRR > MIRR > Multiple IRRs > Conclusion
• 
Payback – Discounted payback 
• 
Net Present Value (NPV) 
• 
Internal Rate of Return (IRR) – Modified IRR (MIRR) Assumes interim CFs reinvested at cost of capital 
45
Slide no. 
Title of image/Source 
Author/Website 
License/Terms of use 
3 
“IPhone at Macworld (rear view)” http://www.flickr.com/photos/blake 
blakeburris https://www.flickr.com/phot 
CC BY 2.0 http://creativecommons.org/licenses/ 
4tx/352328190 
os/blake4tx/ 
by/2.0/deed.en 
46