Saber Electronics provides specialty manufacturing services to defense contractors located in the Seattle, Washington area

million and, management estimates that the firm might generate cash flows for years one through five equal to $500,000;
$2,000,000; and $2,000,000. Saber uses a 20% discount rate for projects of this type. Is this a good investment opportunit

r 20%

Year CF (M) PV
0 -3.00 -3
1 0.50 0.416667
2 0.75 0.520833
3 1.50 0.868056
4 2.00 0.964506
5 2.00 0.803755
NPV via cal 0.573817
NPV via fn ₹ 0.57

NPV = $573,817
The project requires an initial investment of $3,000,000 and generates futures cash flows that have a present value of $
Consequently, the project cash flows are $573,817 more than the required investment.
Since the NPV is positive, the project is an acceptable project.
e Seattle, Washington area. The initial outlay is $3
gh five equal to $500,000; $750,000; $1,500,000;
od investment opportunity?

t have a present value of $3,573,817.

 Project Long Project Short
Year CF Cum CF CF Cum CF
0 -100,000 -100,000 -100,000 -100,000 -100,000 -100,000
1 70,000 -30,000 63,636 -36,364 50,000 -50,000
2 30,000 0 24,793 -11,570 50,000 0
3 30,000 30,000 22,539 10,969 0 0
4 25,000 55,000 17,075 28,045 0 0
5 10,000 65,000 6,209 34,254 0 0

-0.51333333
 The payback period equals two years for both
projects because it takes two years to recover the
cost of the initial outlay from the cash inflows.
-100,000 -100,000 However, Project Long looks a lot better because it
continues to provide cash inflows after the
45,455 -54,545 payback year.
41,322 -13,223
0 -13,223
0 -13,223
0 -13,223
SIMPLE CAPITAL BUDGETING EXAMPLE
Discount rate 15%

1,200.00
Discount
Year Cash flow rate NPV
0 -1,000 0% 1,000.00
1,100.00 =$B$5+NPV(D5,$B$6:$B$11)
1 100 3% 849.34
2 200 6% 637.67 800.00
3 300 9% 457.83
4 400 12% 304.16 600.00
5 500 15% 172.13
6 600 18% 58.10 400.00
NPV 172.13 21% -40.86
IRR 19.71% 24% -127.14 200.00
27% -202.71
30% -269.16 0.00
0% 5% 10%

-200.00

-400.00
 NPV
00.00

00.00

00.00

00.00

00.00

00.00

0.00
0% 5% 10% 15% 20% 25% 30% 35%

00.00

00.00
Maximum payback (years): 3
Required return: 10%
Cum
Cumulative Discounted discounted
t Cash flow cash flow cash flow cash flow
0 -30,000 -30,000 -30,000.00 -30,000
1 8,000 $ (22,000) 7,272.73 $ (22,727)
2 10,000 $ (12,000) 8,264.46 $ (14,463)
3 11,000 $ (1,000) 8,264.46 $ (6,198)
4 17,000 $ 16,000 11,611.23 $ 5,413
5 12,000 $ 28,000 7,451.06 $ 12,864

Payback period for project: 3.06 =3-(D7/C8) 3.058824

Accept or reject? Reject =IF(D1>D11,"Accept","Reject")
Discounted payback period: 3.53 =B7-F7/E8 3.533824
Accept or reject? Reject =IF(D1>D13,"Accept","Reject")
IRR 24.0122% =IRR(C4:C9) 0.240122
Accept or reject? Accept =IF(D15>D2,"Accept","Reject")
NPV 12,863.94 =C4+NPV(D2,C5:C9) 12863.94
Accept or reject? Accept =IF(D17>0,"Accept","Reject")
required return = 0.10
Project A
Time CF Cum CF Disc CF Cum Disc CF
0 -150 -150 -150.00000 -150.00000
1 50 -100 45.45455 -104.54545
2 100 0 82.64463 -21.90083
3 150 150 112.69722 90.79639
Decision
Criteria
PB 2.000 Accept
DiscPB 2.194 Reject
NPV 90.796 Accept
IRR 36.19% Accept
PI 1.605 Accept
 RANKING PROJECTS WITH NPV AND IRR
Discount rate 8%

Year Project A Project B 500

0 -500 -500
1 100 250
2 100 250 400
3 150 200
4 200 100
5 400 50
300

NPV #N/A 200

NPV
IRR #N/A

TABLE OF NPVs AND DISCOUNT RATES 100

Project A Project B
NPV NPV 0
0% 450.00 350.00 =NPV(A17,$C$6:$C$10)+$C$5 0% 5%
2% 382.57 311.53 =NPV(A18,$C$6:$C$10)+$C$5
4% 321.69 275.90 -100
6% 266.60 242.84
8% 216.64 212.11
-200
10% 171.22 183.49
12% 129.85 156.79
14% 92.08 131.84
16% 57.53 108.47
18% 25.86 86.57
20% -3.22 66.00
22% -29.96 46.66
24% -54.61 28.45
26% -77.36 11.28
28% -98.39 -4.93
30% -117.87 -20.25

Calculating the crossover point

Year Project A Project B Cashflow(A) - cashflow(B)
0 -500 -500 0 #NAME?
1 100 250 -150 #NAME?
2 100 250 -150
3 150 200 -50
4 200 100 100
5 400 50 350

IRR 8.51% #NAME?

500

400
Project A
NPV
300
Project B
NPV
200

100

0
0% 5% 10% 15% 20% 25% 30%
-100
Discount rate

-200
 Problems with the IRR Approach
Problem 1: Investing or Financing?
Required return: 10%
The use of the IRR decision rule becomes problematic when the cash flows resemble a loan. Consider the following
t Cash flow
0 $ 25,000
1 (10,000)
2 (11,000)
3 (12,000)
The IRR of this project is:
IRR: 14.77%
The IRR decision rule implies that we should accept projects when the IRR is greater than the required return. So, th
than the IRR. However, the NPV profile for the project looks like this:

Return NPV
0% $ (8,000.00)
5% (4,867.18)
10% (2,197.60)
15% 96.57
20% 2,083.33
25% 3,816.00
30% 5,336.82
With loan-type cash flows, the NPV increases as the interest rate increases. The standard IRR decision rule cannot b
Problem 2: Multiple Rates of Return
Excel uses an algorithm to calculate the IRR of a set of cash flows. Because the algorithm always starts at the same p
this is not a problem, but with multiple IRRs we may want to find both IRRs. In this case, we can use the guess argum
following set of cash flows:

t Cash flow
0 $ (50,000)
1 25,000
2 29,000
3 41,000
4 32,000
5 (35,000)

We would expect two IRRs. Using the IRR function without using the Guess argument, we find:
IRR:
Now we will use the Guess argument to find what the other IRR is:
IRR:

We can graph the NPV profile for this project as well. The NPV profile will look like this:
 Return NPV
-50% $ (164,000.00)
-45% (7,975.42)
-40% 58,847.74
-35% 84,011.95
-30% 89,462.72
-25% 85,720.16
-20% 77,954.10
-15% 68,732.59
-10% 59,321.92
-5% 50,324.30
0% 42,000.00
5% 34,433.78
10% 27,622.31
15% 21,520.38
20% 16,065.46
25% 11,190.40
30% 6,829.92
35% 2,923.56
40% (583.09)
45% (3,738.29)
50% (6,584.36)
55% (9,158.27)
60% (11,492.16)

Mutually Exclusive Investments and Incremental IRR

Even when there is a single IRR, it is not possible to rank projects according to IRR. In other words, the project with t
comparing two mutually exclusive investments, we may want to know the crossover rate, that is, the interest rate th
have the cash flows for two projects:

t Investment A Investment B
0 $ (100,000) $ (110,000)
1 35,000 38,000
2 29,000 36,000
3 29,000 30,000
4 29,000 29,000
5 20,000 21,000

IRR: 14.07% 13.73%

To find the crossover rate, we calculate the incremental cash flows of the larger project, that is, subtract the cash flo
large project. Notice we used an IF statement to makes sure the cash flows below are always the larger project minu
from the larger project are:

Incremental
t cash flows
0 $ (10,000)
1 3,000
2 7,000
3 1,000
4 -
5 1,000

The crossover rate, or incremental IRR, is the IRR of these incremental cash flows, or:

Crossover rate: 9.36%

We can create a table to show the NPV of each project at different interest rates and graph the NPV profile of each

R Investment A Investment B
0% $ 42,000.00 $ 44,000.00
5% 24,217.37 25,071.09
10% 9,799.07 9,683.70
15% (2,044.70) (2,988.31)
20% (11,889.15) (13,547.45)
emble a loan. Consider the following project.

eater than the required return. So, this project looks acceptable for any required return less

e standard IRR decision rule cannot be used in such cases.

algorithm always starts at the same point, it will always arrive at the same IRR. Generally,
this case, we can use the guess argument to try to find multiple IRRs. Suppose we have the

ument, we find:

like this:
IRR. In other words, the project with the highest IRR is not necessarily the best project. When
ssover rate, that is, the interest rate that makes the NPV of the two projects equal. Below we
er project, that is, subtract the cash flows of the smaller project from the cash flows of the
ow are always the larger project minus the smaller project. So, the incremental cash flows

ws, or:

es and graph the NPV profile of each project. Doing so, we get:
The Modified Internal Rate of Return (MIRR)
Excel does have a built-in function to calculate the MIRR, but we work through the MIRR calculation for each metho
manually first. Suppose we have a project with the following cash flows, reinvestment rate, and discount rate:
t Cash flow
0 -12,000
1 5,800
2 6,500
3 6,200
4 5,100
5 (4,300)
Discount rate: 11% 14.64% 14.64%
Reinvestment rate: 8%
With the discounting approach, we discount all negative cash flows to the beginning of the project. In order to have
Excel discount only negative cash flows, we can use an IF statement for each cash flow as follows. Notice that the
equation at time 0 is not a nested IF, but simply a series of IF statements that calculates the present value of each ca
flow if the cash flow is negative, otherwise it returns a value of 0 to be added in to the cash flow. Once we get these
modified cash flows, we can simply calculate the IRR of these cash flows.
Discounting approach:
t Cash flow
0 -14,551.84
1 5,800.00
2 6,500.00
3 6,200.00
4 5,100.00
5 -
MIRR: 23.08%
With the reinvestment approach, we simply find the future value of all cash flows except the cash flow at time 0 at
end of the project and then calculate the IRR of the two remaining cash flows. Doing so, we find that the MIRR using
the reinvestment approach is:
Reinvestment approach:
t Cash flow
0 $ (12,000.00)
1 0.00
2 0.00
3 0.00
4 0.00
5 24,518.64
MIRR: 15.36%
We should note that to have Excel accurately calculate the IRR of these modified cash flows, the intermediate cash
flows must be entered as 0, not left blank.

For the combination approach, we need to find the present value of all negative cash flows at time 0, the future val
of all positive cash flows at the end of the project, then find the IRR of the modified cash flows. Again, we can use a
series of IF statements to test whether each cash flow is negative or positive. So, the MIRR using the combination
approach is:
 Combination approach:
t Cash flow
0 $ (14,551.84)
1 -
2 -
3 -
4 -
5 28,818.64

MIRR: 14.64%

As we mentioned earlier, Excel does have a built-in MIRR function. Using the MIRR function, the MIRR is:

MIRR: 14.64%

What method is Excel using to calculate the MIRR? Of course, remember that Excel was written by computer
programmers, so the method that Excel uses is not necessarily more correct, just the method the programmers
selected.
 calculation for each method
te, and discount rate:

he project. In order to have

follows. Notice that the
he present value of each cash
sh flow. Once we get these

the cash flow at time 0 at the

we find that the MIRR using

ws, the intermediate cash

ws at time 0, the future value

flows. Again, we can use a
R using the combination
on, the MIRR is:

written by computer
thod the programmers
Qn.1
PB Cutoff 2 years
Discount rate 15%
Disc CF Cum CF
Year Project A Project B Project A Project B Project A
0 -15000 -19000 -15000 -19000 -15000
1 10400 12700 9043.4782609 11043.47826087 -4600
2 5900 6100 4461.2476371 4612.47637051 1300
3 2100 5300 1380.7840881 3484.83603189 3400

PB Period 1.780 2.038 Accept Reject 1.78

NPV -114.490013972218 140.7906633 Reject Accept -114.490013972
IRR 14.41% 15.53% Reject Accept

Qn.8
Discount rate 8.5%
Disc CF
Year Project Alpha Project Beta Project Alpha Project Beta
0 -2700 -4100 -2700 -4100
1 1500 900 1382.4884793 829.4930875576
2 1300 2600 1104.2918728 2208.583745673
3 1100 3200 861.19890827 2505.305914978

NPV 647.9792604 1443.3827482

PI 1.239992319 1.3520445727 1.240

Qn.10
Year Cashflows
0 8700
1 -3900
2 -2900
3 -2300
4 -1800

IRR 11.21% 11.21%

NPV (10%) ₹ -199.60 -199.60
NPV (20%) ₹ 1,237.04 1237.04

Qn.11 Discount rate 14%

Year Deepwater Fishing New SubmarineIncremental
0 -725000 -1450000 -725000
1 270000 820000 550000
2 420000 650000 230000
3 380000 540000 160000

IRR 20.96% 19.87% 18.40% 20.96%

NPV 91507.64 133936.76 42429.11 91507.64337745

Qn.12 Discount rate 10%

 Year Cashflows1 Cashflows2 Incremental
0 -45000 -19800 -25200
1 23200 11700 11500
2 23200 11700 11500
3 23200 11700 11500

PI 1.28 1.47 0.18 1.282

NPV 12694.97 9296.17 12694.97

Qn.13
Year Cashflows
0 -65000000
1 92000000
2 -11000000
IRR 28.35% 28.35%

Qn.15 Discount rate 10%

Maximum Investment 20
Year CDMA G4 WI-FI CDMA G4
0 -18000000 -25000000 -43000000 -18000000 -25000000
1 23000000 21000000 39000000 20909090.90909 19090909.09091
2 16000000 51000000 66000000 13223140.49587 42148760.33058
3 6000000 41000000 42000000 4507888.805409 30803906.83696

PI 2.15 3.68
NPV 20,640,120.21 67,043,576.26
Decision
Qn.17 Discount rate 12%
Year Project A Project B Project C Project A Project B
0 -225000 -450000 -225000 -225000 -450000
1 165000 300000 180000 147321.4285714 267857.1428571
2 165000 300000 135000 131536.9897959 239158.1632653

PI 1.239370748299 1.126700680272
NPV 53858.41836735 57015.30612245
if independent ; Decision
Mutually exclusive, Decision
Max Investment 450000, Decsion
Qn.19 CUM CF
Year NP-30 NX-20 NP-30 NX-20
0 -735000 -460000 -735000 -460000
1 239000 130000 -496000 -330000
2 239000 143000 -257000 -187000
3 239000 157300 -18000 -29700
4 239000 173030 221000 143330
5 239000 190333 460000 333663
NP-30 NX-20
Payback 3.08 3.17
IRR 18.74% 19.87%
Qn.24 PI 1.090 1.126
 Year Cashflow NPV 66165.06842473 58158.92969035
0 ($6,048)
1 34344
2 -72840
3 68400
4 -24000

25.00%
33%
67%

Qn.29
Year Project Million Project Billion
0 -1200 Io-
1 160 400
2 960 1200
3 1200 1600
Project B
-19000
-6300
-200
5100

2.038
140.79

1.352

19.87%
133936.7578688
 1.470
9296.17

-86.82%

WI-FI
-43000000
35454545.45455
54545454.54545
31555221.63787

2.83 2.15 3.68 2.83

78,555,221.64 20640120.2104 67043576.258 78555221.638

Project C
-225000
160714.2857143
107621.1734694

1.192602040816 1.24 1.13 1.19

43335.45918367 53858.42 57015.31 43335.46
Accept Accept Accept

Implications
NP-30
NX-20
NX-20
NP-30