Professional Documents
Culture Documents
Minggu 7 Difficulties in Solving For IRR - 12e
Minggu 7 Difficulties in Solving For IRR - 12e
200k 200k
0 1 2 3 4 5 6 7 8 9 10
1500k
610k
7
EGR 403 - Cal Poly Pomona - SA10
Example 7A-1
8
EGR 403 - Cal Poly Pomona - SA10
Cash Flow Rule of Signs
0 0
1 1
2 2 or 0
3 3 or 1
4 4, 2 or 0
Engineering
9
Economic
Cash Flow Rule of Signs
Expands on This Notion
• There may be as many positive values of
“i” as there are sign changes in the cash
flow.
• Sign changes are counted when:
– + to -
– - to +
• A zero cash flow is ignored
Engineering
10
Economic
Cash Flow Rule of Signs
- Possibilities -
0
0
1
1 or 0
2
2, 1 or 0
3
3, 2, 1 or 0
4
4, 3, 2, 1 or 0
Engineering
11
Economic
Zero Sign Changes
• Receiving a gift
• Giving your friend a loan and not being
paid back
Engineering
12
Economic
What to do if cash flow has two or
more sign changes?
• Traditional approach tends to focus attention on
hypothetical possibilities.
• A simpler approach is to graph present worth values over
an appropriate range of negative and positive interest rates.
• In general, the range (−100%, 100%] includes the interest
rates and present worth values that are useful for decision
making.
• When multiple roots occur, there is usually a negative root
that can be ignored and a positive root that can be used.
• If there is only one root and it is negative, then it is a valid
IRR.
50k
0 1 2 3 4 5 6 7
70k
180k
4 +50k $50,00
5 +50k $-
-50% -40% -30% -20% -10% 0% 10% 20% 30% 40% 50%
6 +50k $(50,00)
7 −$70k
$(100,00)
$(150,00)
• In this case, there is one positive root of 10.45%. The value can be
used as an IRR.
• There is also a negative root of −38.29%. This root is not useful.
Copyright Oxford University Press 2014
Example 7A-3
Cash Flow with Multiple Solutions
Adding an oil well to an existing field costs $4M. It will increase
recovered oil by $3.5M, and it shifts $4.5M worth of production
from Years 5, 6, and 7 to earlier years. Thus, the cash flows
for Years 1 through 4 total $8M and Years 5 through 7 total
−$4.5M. If the well is justified, one reason is that the oil is
recovered sooner. How many roots for the PW equation exist?
Is one useful as an IRR, and should the project be funded?
3.5M
2.5M
1.5M 0.5M
0 1 2 3 4 5 6 7
-0.5M
-1.5M
4M
-2.5M
$0,40
1 +3.5M $0,30
2 +2.5M $0,20
3 +1.5M $0,10
4 +0.5M $-
0% 10% 20% 30% 40% 50% 60%
5 −0.5M $(0,10)
$(0,20)
6 −1.5M
$(0,30)
7 −2.5M $(0,40)
$(0,50)
$(0,60)
• In this case, there are positive roots at 4.73 and 37.20%. These
roots are not useful.
3.5M
2.5M
1.5M 0.5M
0 1 2 3 4 5 6 7
-0.5M
-1.5M
4M
-2.5M
F
0 1 2 3 4 5 6 7
0.5M(F/P, 15%,3)+
1.5M(F/P, 15%,4)+
3.5M
2.5M 2.5M(F/P,15%,5)+
1.5M 3.5M(F/P,15%,6)
0.5M =FW(Rt)
0 1 2 3 4 5 6 7 0 1 2 3 4 5 6 7
0.5M
1.5M 4M +
2.5M
0.5M(P/F, 8%, 5) +
4M 1.5M(P/F, 8%, 6) +
2.5M(P/F, 8%, 7)=PW(Et)