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Class 3 (Chapter 9 - Capital Budgeting Criteria)
Class 3 (Chapter 9 - Capital Budgeting Criteria)
I
r
1 -I
Professor Jawad M. Addoum FIN303: Spring 2013
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45
Now with MIRR.
-100.0
MIRR = 23.49%
FV@10% 1 year
152.5
0 1 2
- 100 25 125
27.5
152.5
Calculator Solution
PV=-100
PMT=0
FV=152.5
N= 2
I=? MIRR=23.49%
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Why all this MIRR complication?
Second,
Modified IRR Fixes the Multiple IRR problem
Decision Rules for Independent Projects:
If IRR>WACC, Accept Project
If IRR<WACC, Reject Project
Professor Jawad M. Addoum FIN303: Spring 2013
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Example (slide 35): WACC = 10%
5,000 -5,000
0 1 2
-800
FV@10% 1 year
PV@10% 2 years
5,500
-4,132.2
-4,932.2
MIRR = 5.60%<WACC
5,500
Calculator Solution
PV=-4132.2
PMT=0
FV=5500.0
N= 2
I=? MIRR=5.60%
NPV = -386.78
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Does MIRR fix the Mutually Exclusive Project
problems of IRR?
NO!!!
Technical Note: if the projects are of identical size (identical present values of
negative cash flows (never happens) and positive cash flows for each project are
future valued to the latest period among all projects, then MIRR can fix the cash flow
timing difference problem
Professor Jawad M. Addoum FIN303: Spring 2013
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Advice for choosing between Mutually Exclusive
Projects:
Always choose NPV over both MIRR and IRR
when deciding between mutually exclusive projects!!
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Major points
As always, know how to work the assigned
homework problems as well as the types of
numerical examples in the notes
What is capital budgeting?
What are the following investment criteria? What
are their relative advantages? Disadvantages?
Payback
Discounted Payback
Net Present Value (NPV)
Internal Rate of Return (IRR)
Modified Internal Rate of Return (MIRR)
Professor Jawad M. Addoum FIN303: Spring 2013
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Relative to NPV, what are the relative shortcomings
of the other investment criteria?
What is the weakness of IRR in choosing between mutually
exclusive projects? Projects with nonconventional cash
flows?
How do NPV profiles provide additional insight in the
investment analysisespecially as compared to IRR
analysis?
How is MIRR useful?
52
Appendix: Another MIRR
Example
Example: Consider Project H and its cash flows
($000). The WACC is 10%:
What is Project Hs MIRR?
NPV = $81,573.
0 1 2 3 4
- 260 107 -11.8 89 117
Professor Jawad M. Addoum FIN303: Spring 2013
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Example (continued):
-269.75
MIRR = ?
117.0
97.9
142.4
FV@10%
PV@10%
FV@10%
357.3
-9.75
0 1 2 3 4
- 260 107 -11.8 89
Calculator Solution
PV=-269.75
PMT=0
FV=357.3
N= 4
I=? MIRR=7.28%
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Math Solution
MIRR = 7.28%
Professor Jawad M. Addoum FIN303: Spring 2013
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1a. Enter positive CFs:
CF
0
=0
CF
1
=107
CF
2
=0
CF
3
=89
CF
4
=117
I = 10
NPV =?244.1
STO 1
2. (RCL 1) PV =-244.1 N = 4, I = 10 PMT = 0; FV =?357.3 STO 3
3. (RCL 2 ) PV=-269.75 (RCL 3) FV=357.3 N = 4 PMT= 0; I = ?
MIRR = 7.28%
Pure Calculator Solution (messy!)
1b. Enter negative CFs:
CF
0
=260
CF
1
=0
CF
2
=11.8
CF
3
=0
CF
4
=0
I = 10
NPV =?$269.75
STO 2