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Lecture 8 The Basics of Capital Budgeting Learning Objectives

Understand the difference between normal and non-normal cash flow streams.

Understand the difference between mutually exclusive and independent projects.

Calculate and use the major capital budgeting decision

criteria, which are the 1) payback period, 2) discounted payback period, 3) Net Present Value (NPV), 4) Internal Rate of Return (IRR), and 5) Modified IRR (MIRR) for mutually exclusive and independent projects.

Discuss the strengths and weaknesses of each method.

Understand and interpret the NPV profile.

Calculate and understand the importance of the crossover point.

Discuss the conflict between NPV and IRR when evaluating mutually exclusive projects.

Understand why NPV is superior to IRR and MIRR.

Understand the multiple IRRs problem.

AB1201: Financial Management

Lecture 8 The Basics of Capital Budgeting

By: Angie Low

Introduction > Normal vs. Non-normal CFs > Independent vs. mutually exclusive projects > Payback period > Discounted payback period > Calculating NPV > NPV profiles > IRR > NPV vs. IRR > MIRR > Multiple IRRs > Conclusion

Introduction > Normal vs. Non-normal CFs > Independent vs. mutually exclusive projects > Payback period >

Introduction > Normal vs. Non-normal CFs > Independent vs. mutually exclusive projects > Payback period > Discounted payback period > Calculating NPV > NPV profiles > IRR > NPV vs. IRR > MIRR > Multiple IRRs > Conclusion

Steps to Capital Budgeting

  • 1. Estimate CFs.

Initial investments.

Subsequent cash inflows/ outflows.

  • 2. Assess riskiness of CFs and determine the appropriate risk-adjusted cost of capital for discounting cash flows.

  • 3. Find NPV and/or IRR(MIRR).

Introduction > Normal vs. Non-normal CFs > Independent vs. mutually exclusive projects > Payback period > Discounted payback period > Calculating NPV > NPV profiles > IRR > NPV vs. IRR > MIRR > Multiple IRRs > Conclusion

Capital Budgeting Decision Criteria

Payback

Discounted payback

Net Present Value (NPV) Internal Rate of Return (IRR)

Modified IRR (MIRR)

Introduction > Normal vs. Non-normal CFs > Independent vs. mutually exclusive projects > Payback period > Discounted payback period > Calculating NPV > NPV profiles > IRR > NPV vs. IRR > MIRR > Multiple IRRs > Conclusion

An Illustrative Example

Here are the projects’ expected after-tax cash flows (in thousands of dollars):

0

1

2

3

 

|

|

|

|

Project L

-100

10

60

80

Project S

-100

70

50

20

Cost of capital = 10% for both projects Which project(s) should we take up? How should we analyse them?

Introduction > Normal vs. Non-normal 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 Flow Streams versus Non-normal Cash Flow Streams?

Normal cash flow stream Cost (negative CF) followed by a series of positive cash inflows.

One change of signs.

Non-normal cash flow stream Two or more changes of signs.

Most common: Cost (negative CF), then string of positive CFs, then cost to close project (negative CF).

Introduction > Normal vs. Non-normal 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 versus Mutually Exclusive Projects

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.

Only one of the projects can be accepted

Introduction > Normal vs. Non-normal CFs > Independent vs. mutually exclusive projects > Payback period > Discounted payback period > Calculating NPV > NPV profiles > IRR > NPV vs. IRR > MIRR > Multiple IRRs > Conclusion

Capital Budgeting Decision Criteria

Payback

Discounted payback

Net Present Value (NPV)

Internal Rate of Return (IRR)

Modified IRR (MIRR)

0

1

2

3

 

|

|

|

|

Project L

-100

10

60

80

Project S

-100

70

50

20

Introduction > Normal vs. Non-normal CFs > Independent vs. mutually exclusive projects > Payback period > Discounted payback period > Calculating NPV > NPV profiles > IRR > NPV vs. IRR > MIRR > Multiple IRRs > Conclusion

What is the Payback Period?

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

cost until the cumulative cash flow for the project

turns positive.

Introduction > Normal vs. Non-normal CFs > Independent vs. mutually exclusive projects > Payback period > Discounted payback period > Calculating NPV > NPV profiles > IRR > NPV vs. IRR > MIRR > Multiple IRRs > Conclusion

Calculating Payback

Project L’s Payback Calculation

0 1 2 3
0
1
2
3

CF t Cumulative

-100

Payback L

=

Payback S

=

10 60 80 Mutually exclusive Choose the one with shorter payback! Independent Subjective benchmark has to
10
60
80
Mutually exclusive
Choose the one with shorter
payback!
Independent
Subjective benchmark has to be
used. E.g. Only projects with
payback of less than three years
are accepted.

Introduction > Normal vs. Non-normal CFs > Independent vs. mutually exclusive projects > Payback period > Discounted payback period > Calculating NPV > NPV profiles > IRR > NPV vs. IRR > MIRR > Multiple IRRs > Conclusion

Weaknesses and Strengths of Payback Method

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.

Introduction > Normal vs. Non-normal CFs > Independent vs. mutually exclusive projects > Payback period > Discounted payback period > Calculating NPV > NPV profiles > IRR > NPV vs. IRR > MIRR > Multiple IRRs > Conclusion

Discounted Payback Period

Uses discounted cash flows rather than raw CFs. Cost of capital 0 1 2 3 10%
Uses discounted cash flows rather than raw CFs.
Cost of capital
0
1
2
3
10%

CF t

-100

10

60

80

PV of CF t

-100

9.09

49.59

60.11

Cumulative

-100

-90.91

-41.32

18.79

Disc Payback L = Disc Payback S =

Introduction > Normal vs. Non-normal CFs > Independent vs. mutually exclusive projects > Payback period > Discounted payback period > Calculating NPV > NPV profiles > IRR > NPV vs. IRR > MIRR > Multiple IRRs > Conclusion

Lessons Learnt 1

Normal cash flows versus non-normal cash flows.

Independent versus mutually exclusive projects.

Payback period is the number of years it takes to

recover project’s initial investment.

To calculate the payback period, we cumulate the cash flows. Discounted payback period builds on the payback period method by cumulating the discounted cash flows. Decision criteria:

  • Independent projects: A subjective payback benchmark needs to be used. Projects are accepted only if payback < benchmark.

  • Mutually exclusive projects: Choose the one with shorter payback.

Introduction > Normal vs. Non-normal CFs > Independent vs. mutually exclusive projects > Payback period > Discounted payback period > Calculating NPV > NPV profiles > IRR > NPV vs. IRR > MIRR > Multiple IRRs > Conclusion

Capital Budgeting Decision Criteria

Payback

Discounted payback

Net Present Value (NPV) Internal Rate of Return (IRR)

Modified IRR (MIRR)

Introduction > Normal vs. Non-normal CFs > Independent vs. mutually exclusive projects > Payback period > Discounted payback period > Calculating NPV > NPV profiles > IRR > NPV vs. IRR > MIRR > Multiple IRRs > Conclusion

Net Present Value (NPV)

Sum of the PVs of all cash inflows and outflows of a project:

NPV

N

t

0

CF

t

( 1

r )

t

CF

1

CF

2

CF

0


1


2

( 1 r )

( 1

r )

Introduction > Normal vs. Non-normal CFs > Independent vs. mutually exclusive projects > Payback period >
Introduction > Normal vs. Non-normal CFs > Independent vs. mutually exclusive projects > Payback period >

Cost of capital

Initial Investment

CF

N

( 1

r )

N

Introduction > Normal vs. Non-normal CFs > Independent vs. mutually exclusive projects > Payback period > Discounted payback period > Calculating NPV > NPV profiles > IRR > NPV vs. IRR > MIRR > Multiple IRRs > Conclusion

What is Project L’s NPV?

Project L

0

1

2

3

|

|

|

|

-100

10

60

80

NPV

L

-100

10

( 1

0.1 )

1

60

( 1

0.1 )

2

80

( 1

0.1 )

3

$18.79

Financial calculator: Enter CFs into the calculator’s CFLO register.

Important to show NPV working in exams! Do not need to show calculator entries
Important to show
NPV working in exams!
Do not need to show
calculator entries

CF0 = -100 CF1 = 10

CF2 = 60

CF3 = 80 Enter I/YR = 10, press NPV button to get NPV L = $18.79.

Introduction > Normal vs. Non-normal CFs > Independent vs. mutually exclusive projects > Payback period > Discounted payback period > Calculating NPV > NPV profiles > IRR > NPV vs. IRR > MIRR > Multiple IRRs > Conclusion

What is Project S’s NPV?

Project S

0

1

2

3

 

|

|

|

|

-100

70

50

20

Introduction > Normal vs. Non-normal CFs > Independent vs. mutually exclusive projects > Payback period > Discounted payback period > Calculating NPV > NPV profiles > IRR > NPV vs. IRR > MIRR > Multiple IRRs > Conclusion

Rationale for the NPV Method

NPV = PV of Inflows PV of Costs = Net gain in wealth

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.

Introduction > Normal vs. Non-normal CFs > Independent vs. mutually exclusive projects > Payback period > Discounted payback period > Calculating NPV > NPV profiles > IRR > NPV vs. IRR > MIRR > Multiple IRRs > Conclusion

Rationale for the NPV Method

NPV = PV of Inflows PV of Costs = Net gain in wealth

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.

Accept S since NPV S > NPV L

Introduction > Normal vs. Non-normal CFs > Independent vs. mutually exclusive projects > Payback period > Discounted payback period > Calculating NPV > NPV profiles > IRR > NPV vs. IRR > MIRR > Multiple IRRs > Conclusion

NPV Profiles

A graphical representation of project NPVs at various different costs of capital.

Cost of Capital

NPV L

NPV S

0

$50

$40

5

33

29

10

19

20

15

7

12

20

(4)

5

Introduction > Normal vs. Non-normal CFs > Independent vs. mutually exclusive projects > Payback period > Discounted payback period > Calculating NPV > NPV profiles > IRR > NPV vs. IRR > MIRR > Multiple IRRs > Conclusion

Drawing NPV profiles

NPV

($) 60 . 50 . 40 . . 30 . 20 Crossover Point = 8.7% .
($)
60
.
50
.
40
.
.
30
.
20
Crossover Point = 8.7%
.
.
S
10
.
.
.
.
0
Discount Rate (%)
5
10
15
L
20
23.6
-10

Introduction > Normal vs. Non-normal CFs > Independent vs. mutually exclusive projects > Payback period > Discounted payback period > Calculating NPV > NPV profiles > IRR > NPV vs. IRR > MIRR > Multiple IRRs > Conclusion

Lessons Learnt 2

 

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:

  • Independent projects: Projects are accepted only if NPV > 0.

  • Mutually exclusive projects: Choose the one with higher NPV.

NPV profile is a graphical representation of project

NPVs at various different cost of capital.

The choice of project differs depending on whether the discount rate is higher or lower than the crossover point.

Introduction > Normal vs. Non-normal CFs > Independent vs. mutually exclusive projects > Payback period > Discounted payback period > Calculating NPV > NPV profiles > IRR > NPV vs. IRR > MIRR > Multiple IRRs > Conclusion

Capital Budgeting Decision Criteria

Payback

Discounted payback

Net Present Value (NPV)

Internal Rate of Return (IRR)

Modified IRR (MIRR)

Introduction > Normal vs. Non-normal CFs > Independent vs. mutually exclusive projects > Payback period > Discounted payback period > Calculating NPV > NPV profiles > IRR > NPV vs. IRR > MIRR > Multiple IRRs > Conclusion

Internal Rate of Return (IRR)

IRR is the discount rate that forces NPV = 0:

0

N

t 0

CF

t

(1 IRR)

t

IRR is the expected annual rate of return that the firm will earn if it invests in the project and

receives the given cash flows.

Introduction > Normal vs. Non-normal CFs > Independent vs. mutually exclusive projects > Payback period > Discounted payback period > Calculating NPV > NPV profiles > IRR > NPV vs. IRR > MIRR > Multiple IRRs > Conclusion

IRR for Project L

 

0

1

2

 

3

|

|

|

|

 

Project L

 

-100

 

10

60

 

80

 
   

10

  • 60 80

 
 

0

-100

     

( 1

IRR

  • L )

  • 1

( 1

IRR

  • L )

  • 2

( 1

IRR

  • L )

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%.

Introduction > Normal vs. Non-normal CFs > Independent vs. mutually exclusive projects > Payback period > Discounted payback period > Calculating NPV > NPV profiles > IRR > NPV vs. IRR > MIRR > Multiple IRRs > Conclusion

What is the IRR for Project S?

Project S

0

1

2

3

 

|

|

|

|

-100

70

50

20

Introduction > Normal vs. Non-normal CFs > Independent vs. mutually exclusive projects > Payback period > Discounted payback period > Calculating NPV > NPV profiles > IRR > NPV vs. IRR > MIRR > Multiple IRRs > Conclusion

Decision Criteria for IRR Method

If IRR > cost of capital, the project’s return exceeds

its costs and there is some return left over to boost

stockholders’ returns.

Mutually exclusive projects: Independent projects: Accept project with highest IRR If IRR > cost of capital,
Mutually exclusive projects:
Independent projects:
Accept project with highest IRR
If IRR > cost of capital, accept project.
provided project IRR > cost of
If IRR < cost of capital, reject project.
capital.

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 .

Introduction > Normal vs. Non-normal CFs > Independent vs. mutually exclusive projects > Payback period > Discounted payback period > Calculating NPV > NPV profiles > IRR > NPV vs. IRR > MIRR > Multiple IRRs > Conclusion

Comparing NPV and IRR

NPV ($) 60 . 50 . 40 . . 30 . Crossover Point = 8.7% 20
NPV
($)
60
.
50
.
40
.
.
30
.
Crossover Point
= 8.7%
20
.
.
S
10
.
.
.
.
0
L
5
10
15
20
23.6
-10

Discount Rate (%)

Introduction > Normal vs. Non-normal CFs > Independent vs. mutually exclusive projects > Payback period > Discounted payback period > Calculating NPV > NPV profiles > IRR > NPV vs. IRR > MIRR > Multiple IRRs > Conclusion

Comparing the NPV and IRR methods

If projects are independent, the two methods always lead to the same accept/reject decisions.

If projects are mutually exclusive

If discount rate > crossover rate, the methods lead to the same decision and there is no conflict.

If discount rate < crossover rate, the methods lead to different accept/reject decisions.

Introduction > Normal vs. Non-normal CFs > Independent vs. mutually exclusive projects > Payback period > Discounted payback period > Calculating NPV > NPV profiles > IRR > NPV vs. IRR > MIRR > Multiple IRRs > Conclusion

Comparing the NPV and IRR methods

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.

Introduction > Normal vs. Non-normal CFs > Independent vs. mutually exclusive projects > Payback period > Discounted payback period > Calculating NPV > NPV profiles > IRR > NPV vs. IRR > MIRR > Multiple IRRs > Conclusion

NPV is Superior 1) Reinvestment rate assumptions

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.

NPV method is better.

NPV method should be used to choose between mutually exclusive projects.

Introduction > Normal vs. Non-normal CFs > Independent vs. mutually exclusive projects > Payback period > Discounted payback period > Calculating NPV > NPV profiles > IRR > NPV vs. IRR > MIRR > Multiple IRRs > Conclusion

NPV is Superior 2) Projects with different scales

Suppose a firm with adequate access to capital and a 10% cost

of capital is choosing between two equally risky, mutually exclusive projects. Both projects will last for 10 years.

 

Project Large (L)

Project Small (S)

CF 0

-$100,000

-$1.00

CF 1-10

$50,000

$0.60

WACC

10%

10%

NPV

   

IRR

   

Box titled “Why NPV is better than IRR”. Adapted from Essentials of Financial Management (p. 414), by Brigham, Houston, Hsu, Kong, and Bany-Ariffin, 2013, Singapore: Cengage Learning.

Introduction > Normal vs. Non-normal CFs > Independent vs. mutually exclusive projects > Payback period > Discounted payback period > Calculating NPV > NPV profiles > IRR > NPV vs. IRR > MIRR > Multiple IRRs > Conclusion

Lessons Learnt 3

N CF 0   t t (  1 IRR ) t0 
N
CF
0 
t
t
( 
1
IRR )
t0

IRR is the discount rate that forces NPV = 0

IRR is the expected annual rate of return on a project. Decision criteria:

  • Independent projects: Projects are accepted only if IRR > cost of capital.

  • Mutually exclusive projects: Choose the one with higher IRR.

For independent projects, IRR and NPV always gives the same

accept/reject decision. For mutually exclusive projects, IRR and NPV may give conflicting decision:

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

affected when evaluating projects with different scale.

Introduction > Normal vs. Non-normal CFs > Independent vs. mutually exclusive projects > Payback period > Discounted payback period > Calculating NPV > NPV profiles > IRR > NPV vs. IRR > MIRR > Multiple IRRs > Conclusion

Capital Budgeting Decision Criteria

Payback

Discounted payback

Net Present Value (NPV) Internal Rate of Return (IRR)

Modified IRR (MIRR)

Introduction > Normal vs. Non-normal CFs > Independent vs. mutually exclusive projects > Payback period > Discounted payback period > Calculating NPV > NPV profiles > IRR > NPV vs. IRR > MIRR > Multiple IRRs > Conclusion

Since managers prefer the IRR to the NPV method, is there a better IRR measure?

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

the PV of a project’s terminal value (TV) to equal

the PV of costs. TV is found by compounding inflows

at cost of capital.

Introduction > Normal vs. Non-normal CFs > Independent vs. mutually exclusive projects > Payback period > Discounted payback period > Calculating NPV > NPV profiles > IRR > NPV vs. IRR > MIRR > Multiple IRRs > Conclusion

Calculating MIRR

0 1 2 3 10%
0
1
2
3
10%

-100.0

10.0 60.0
10.0
60.0

80.0

66.0

12.1

Discount @ MIRR to t = 0

Introduction > Normal vs. Non-normal CFs > Independent vs. mutually exclusive projects > Payback period >
$158.1
$158.1
$100
$100

=

(1+MIRR) 3 MIRR L = 16.5%

158.1
158.1

TV inflows

PV outflows

Introduction > Normal vs. Non-normal CFs > Independent vs. mutually exclusive projects > Payback period > Discounted payback period > Calculating NPV > NPV profiles > IRR > NPV vs. IRR > MIRR > Multiple IRRs > Conclusion

Recap: MIRR method

To calculate MIRR:

PV (cash outflows)= PV (terminal values of cash inflows)

PV cash outflows  PV (TV cash inflows) N Nt  CIF (1  r )
PV cash outflows  PV (TV cash inflows)
N
Nt 
CIF
(1
r
)
N
COF
t
t0
t
N
(1
 r
)
( 1  MIRR )
t  0

Introduction > Normal vs. Non-normal CFs > Independent vs. mutually exclusive projects > Payback period > Discounted payback period > Calculating NPV > NPV profiles > IRR > NPV vs. IRR > MIRR > Multiple IRRs > Conclusion

What is the MIRR for Project S?

Project S

0

1

2

3

 

|

|

|

|

-100

70

50

20

Introduction > Normal vs. Non-normal CFs > Independent vs. mutually exclusive projects > Payback period > Discounted payback period > Calculating NPV > NPV profiles > IRR > NPV vs. IRR > MIRR > Multiple IRRs > Conclusion

Why use MIRR versus IRR?

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

give the same accept/ reject decisions.

Introduction > Normal vs. Non-normal CFs > Independent vs. mutually exclusive projects > Payback period > Discounted payback period > Calculating NPV > NPV profiles > IRR > NPV vs. IRR > MIRR > Multiple IRRs > Conclusion

Multiple IRRs Example:

Find Project P’s NPV and IRR.

Project P has cash flows (in 000s): CF 0 = -$0.8 million, CF 1 = $5 million, and CF 2 = -$5 million.

0 1 2 10% -800 5,000 -5,000
0
1
2
10%
-800
5,000
-5,000

Enter CFs into calculator CFLO register.

Enter I/YR = 10.

NPV = -$386.78.

IRR = 25% or ERROR

Why?

Non-normal Cash flows!
Non-normal
Cash flows!

Introduction > Normal vs. Non-normal CFs > Independent vs. mutually exclusive projects > Payback period > Discounted payback period > Calculating NPV > NPV profiles > IRR > NPV vs. IRR > MIRR > Multiple IRRs > Conclusion

NPV Profiles: Multiple IRRs

Suspect multiple IRRs problem if the CFs are non- normal and if cash inflows and outflows
Suspect multiple IRRs
problem if the CFs are non-
normal and if cash inflows
and outflows are roughly
similar in magnitude
IRR 2 = 400%
100
400
IRR 1 = 25%

NPV

450

0

Discount rate

-800

Introduction > Normal vs. Non-normal CFs > Independent vs. mutually exclusive projects > Payback period > Discounted payback period > Calculating NPV > NPV profiles > IRR > NPV vs. IRR > MIRR > Multiple IRRs > Conclusion

When to use the MIRR instead of the IRR? Accept Project P?

When there are non-normal CFs and more than one IRR, use MIRR.

MIRR of Project P:

0 1 2 10% -800 5,000 -5,000
0
1
2
10%
-800
5,000
-5,000

Do not accept Project P.

NPV = -$386.78 < 0.

MIRR = 5.6% < Cost of capital =10%.

Introduction > Normal vs. Non-normal CFs > Independent vs. mutually exclusive projects > Payback period > Discounted payback period > Calculating NPV > NPV profiles > IRR > NPV vs. IRR > MIRR > Multiple IRRs > Conclusion

Lessons Learnt 4

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.

NPV is superior to MIRR.

Introduction > Normal vs. Non-normal CFs > Independent vs. mutually exclusive projects > Payback period > Discounted payback period > Calculating NPV > NPV profiles > IRR > NPV vs. IRR > MIRR > Multiple IRRs > Conclusion

Capital Budgeting Decision Criteria

Payback Discounted payback

Net Present Value (NPV)

Internal Rate of Return (IRR) Modified IRR (MIRR) Assumes interim CFs reinvested at cost of capital

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