CF2023 - BA - Chapter 4 - Investment Appraisal

Faculty of Finance
Department of Corporate Finance
CHAPTER 4
INVESTMENT APPRAISAL
Tran Thanh Thu, PhD
Dao Hong Nhung, PhD
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Faculty of Finance
Learning Objectives:
o To be able to indicate the relevant cash flows of a project
o To apply different techniques for investment evaluation
o To understand special cases of discounted cash flow analysis
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Content
4.1 Project cash flows (CF) 4.1.1. Determining the cash flows
4.1.2. Inflation and Cash Flows
4.2 Investment evaluation techniques
4.2.1 The Net Present Value (NPV)
4.2.2 The Internal Rate of Return (IRR)
4.2.3 The Pay Back Period (PB)
4.2.4 The Discounted Pay Back Period
4.2.5 The Profitability Index (PI)
4.3 Special cases of DCF Analysis
4.3.1 Cost – cutting investments
4.3.2 Competitive bidding
4.3.3 Equipment with different lives
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4.1.Project Cash Flows

4.1.1. Determining Cash Flows
Incremental Cash Flows, Not Accounting Income
Excluding Sunk Costs
Considering Opportunity Costs
Taking into account Side Effects
Be careful with allocated costs
No financing expenses
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q Only cash flows that are incremental to the project
should be used.
q Incremental cash flows: the changes in the firm’s cash
flows occuring as a direct consequences of accepting the
project. Incremental
CFs
A project
No Project With project
cash flows Cash flows
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q Non-cash items on Income Statement
q Certain uses of cash such as the purchase of building or
expenditure on inventory are not reported on the IS
q To buy necessary assets for a project, the firm needs
cash
Part II Valuation and Capital Budgeting
Relevant Cash Flows The Weber-Decker Co. just paid $1 million in cash for a building as part
of a new capital budgeting project. This entire $1 million is an immediate cash outflow. However,
assuming straight-line depreciation over 20 years, only $50,000 (5$1 million/20) is considered an
accounting expense in the current year. Current earnings are thereby reduced by only $50,000. The
remaining $950,000 is expensed over the following 19 years. For capital budgeting purposes, the
relevant cash outflow at Date 0 is the full $1 million, not the reduction in earnings of only $50,000.
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Year 1 Year 2 Year 3 Total

Net Revenue ($million) 1,200 1,200 1,200 3,600
Operating expense 600 600 600 1,800
Depreciation 400 400 400 1,200
Pre-tax profit 200 200 200 600
Tax@20% 40 40 40 120
Profit after tax 160 160 160 480
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Year 0 Year 1 Year 2 Year 3 Total

Net Revenue ($million) 1,200 1,200 1,200 3,600
Operating expense 600 600 600 1,800
Fixed asset (1,200)
Pre-tax cash flows (1,200) 600 600 600 1,800
Tax@20% 40 40 40 120
Cash flows after tax (1,200) 560 560 560 480
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q A sunk cost is a cost that has already occurred.
q Sunk costs are in the past, they cannot be changed by
the decision to accept or reject the project.
The General Milk Company (GMC) is currently evaluating the project
of establishing a line of chocolate milk. As part of the evaluation, the
company paid a consulting firm $100,000 last year for a test
marketing analysis.
Is this cost relevant for the capital budgeting decision now
confronting GMC’s management?
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q A sunk cost is a cost that has already occurred.
q Sunk costs are in the past, they cannot be changed by
the decision to accept or reject the project.
The answer is NO. The $100,000 is not recoverable and already

spent. Acceptance of the project does not affect this cash flow. Once
the company incurred the expense, the cost became irrelevant for
any future decision.
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Considering Opportunity Costs
q Opportunity cost is the most valuable alternative given up
if a particular investment is undertaken.
q The opportunity cost of using an existing asset in a project
means the cash flow generated by the next-best
alternative use for the asset.
Suppose the Weinstein Trading Company has an empty warehouse in
Philadelphia that can be used to store a new line of electronic pinball
machines. Should the warehouse be considered a cost in the
decision to sell the machines?
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q Side effects: the effects of a proposed project on the other
parts of the firm
q Erosion: when a new project reduces the sales =>
the cash flows of existing products
q Synergy: when a new project increases the cash flows
of existing projects
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Suppose the Innovative Motors Corporation (IMC) is

considering an investment in a new convertible sport cars.
Potential consumers of this type would be owners of IMC’s
compact sedans. Are all sales and profits from the new
convertible sports cars incremental?
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The answer is no because some of the cash flow represents transfers

from other elements of IMC’s product line. This is erosion, which must be
included in the NPV calculation. Without taking erosion into account,
IMC might erroneously calculate the NPV of the sports car to be.
If the NPV of the sport cars are $100 million, and half the customers are
transfers from the sedan and lost sedan sales have an NPV of -$150
million, the true NPV is -$50 million (=$100 million - $150 million).
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IMC is also contemplating the formation of a racing team.

The team is forecast to lose money for the foreseeable future with the
best projection showing an NPV of - $35 million
The team will likely generate great publicity for IMC’s products => NPV
of the increase cash flows is $65 million
Assuming that the estimation of synergy is trustworthy.
The net present value of the team is…………………………………….
The managers should…………………………………………………….....
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Allocated cost
q Expenditure benefits a number of projects
q Accountants allocate this cost across the different projects
when determining income
q For capital budgeting: allocated cost should be viewed
as a cash outflow of a project only if it is an
incremental cost of the project
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Allocated cost
The Voetmann Consulting Corp. devotes one wing of its suite of offices to
a library requiring a cash outflow of $100,000 a year in upkeep. A
proposed capital budgeting project is expected to generate revenue equal
to 5 percent of the overall firm’s sales. An executive at the firm, David
Pedersen, argues that $5,000 (5 percent of $100,000) should be
viewed as the proposed project’s share of the library’s costs. Is
this appropriate for capital budgeting?
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Initial investments
The cash outflows (Investment in Fixed assets and NWC)
(1) Additional capital expenditures
And Changes in WC
Taxes
The project
cash flows
Operating cash flows (OCF)
The cash inflows
(2) Depreciation/Amortization
WC recovery
Salvage value
Deductible tax expenses
The net cash flows

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Step 1: Estimating the cash flows at the beginning of the project (Year 0)
The project life

… …
0 1 2 n- k n- 1 n
Initial investments Opt. Costs o Sales from old assets Irrelevant factors:
o Tax implication -Sunk cost
-Allocated cost
-Fixed overhead
Fixed assets Net Working capital -Financing expense
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Step 2: Estimating cash flows during the project’s life from year 1 to year n
- Estimate the OCF
- Additional capital expenditure and changes in net working capital
- The side effects of the project
(1)
The bottom-up: NI + Depreciation
(2)
The top-down : Sales – Cash Costs - Taxes
OCF
(3)
The tax shield : (Sales – Cash Costs)*(1-tc) + Depreciation*tc
OCF OCF OCF OCF OCF

The project life
… …
0 1 2 n- k n- 1 n
o Additional investment
o Side effects (Externalities)
10/11/23 Note: tc is the income tax rate 20
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Step 3: Estimating the cash flows when terminating the project (year n)
WC recovery
Salvage value
Tax implication relating

to asset disposal
The project life
… …
0 1 2 n- k n
Step 4: Estimating the net cash flow for each year of the project
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Case: Baldwin Company
The Baldwin Company, originally established 16 years ago to make
footballs, is now a leading producer of tennis balls, baseballs, footballs,
and golf balls. Company is now considering investing in a machine to
produce bowling balls.
The Company investigated the marketing potential of brightly

colored bowling balls. The cost of the test marketing, which was
$250,000.
The bowling balls would be manufactured in a building owned by the

firm and located near Los Angeles. This building, which is vacant, and
the land can be sold for $150,000 after taxes.
The cost of the bowling ball machine is $100,000 and it is expected to last
five years. At the end of five years, the machine will be sold at a price
estimated to be $30,000.
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Case: Baldwin Company (Con’t)
Production by year during the five-year life of the machine is expected to
be as follows: 5,000 units, 8,000 units, 12,000 units, 10,000 units, and
6,000 units.
The price of bowling balls in the first year will be $20 with an increase
of 2% per annum, as compared to the anticipated general inflation
rate of 5 percent.
The plastic used to produce bowling balls is rapidly becoming more
expensive. Because of this, production cash outflows are expected to
grow at 10 percent per year. First-year production costs will be $10 per
unit.
Management determines that an initial investment (at Year 0) in net
working capital of $10,000 is required. Subsequently, net working capital
at the end of each year will be equal to 10 percent of sales for that year.
In the final year of the project, net working capital will decline to zero as
the project is wound down. In other words, the investment in working
capital is to be completely recovered by the end of the project’s life.
Income tax rate = 34%
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the end of the year.)
Investment
Year 0 Year 1 Year 2 Year 3 Year 4 Year 5
Investments:
(1) Bowling ball machine −$100.00 $ 21.76*
(2) Accumulated depreciation $ 20.00 $ 52.00 $ 71.20 $ 82.72 94.24
(3) Adjusted basis of machine after 80.00 48.00 28.80 17.28 5.76
depreciation (end of year)
(4) Opportunity cost (warehouse) −150.00 150.00
(5) Net working capital (end of year) 10.00 10.00 16.32 24.97 21.22
(6) Change in net working capital −10.00 −6.32 −8.65 3.75 21.22
(7) Total cash flow of investment −260.00 −6.32 −8.65 3.75 192.98
[(1) 1 (4) 1 (6)]
Income:
(8)Explain:
Sales revenues $100.00 $163.20 $249.70 $212.24 $129.89
(9)$25,000 marketing expense => sunk cost
Operating costs −50.00=> Ignore
−88.00 −145.20 −133.10 −87.85
Depreciation vacant building after tax => −20.00
(10)$150,000 −32.00
opportunity −19.20
cost => −11.52
Relevant −11.52
(11) Income before taxes $ 30.00 $ 43.20 $ 85.30 $ 67.62 $ 30.53
Fixed asset disposal:
[(8) 1 (9) 1 (10)]
At Year 5
+ Written Down Value = 5.76
(12) Tax at 34 percent −10.20 −14.69 −29.00 −22.99 −10.38
(13)+NetSalvage
income value = 30 $ 19.80 $ 28.51 $ 56.30 $ 44.63 $ 20.15
+ Taxable gain = 30 – 5.76 = 24.24 => After tax salvage value = 21.76
NWC
*We assume Investment:
that the sale price of the bowling ball machine at year 5 will be $30 (in thousands). The machine will have been depreciated to $5.76 at that time.
+ Only consider the change in NWC
Therefore, the taxable gain from the sale will be $24.24 (5$30 2 $5.76). The aftertax salvage value will be $30 − [.34 3 ($30 − $5.76)] 5 $21.76.
+ Finish recovery at the end of Year 5
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Net Working Capital Investment
Net Working Capital = Current Assets – Current Liabilities
An investment in NWC arises when:
- Inventory is purchased
- Cash is kept in the project as a buffer against unexpected
expenditures
- Sales are made on credit => AR
Determining NWC for Baldwin in Year 2
- $9,000 of the sales will be on credit => AR = $9,000
- Operating costs: $50,000 but deferred payment of $3,000 => AP =
$3,000
- Inventory of $2,500 should be kept to avoid running out =>
Inventory = $2,500
- Cash reserve = $1,500
WC requirement = 1,500 + 2,500 + 9,000 – 3,000 = 10,000
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Part II Sales Revenues and Operating costs
Valuation and Capital Budgeting
(1) (2) (3) (4) (5) (6)

Quantity Sales Cost Operating
Costs Year Sold Price Revenues per Unit Costs
1 5,000 $20.00 $100,000 $10.00 $ 50,000

2 8,000 20.40 163,200 11.00 88,000
3 12,000 20.81 249,696 12.10 145,200
4 10,000 21.22 212,242 13.31 133,100
5 6,000 21.65 129,892 14.64 87,846
Price rises at 2% per year. Unit cost risesIncrease

at 10% per year. Reported prices and costsIncrease
(columns 3 and 5) are rounded to two
digits after the decimal. Sales revenues andby 2% per
operating by 10%
costs (columns 4 and 6) are calculated peri.e., nonrounded, prices
using exact,
and costs.
year year
Recovery Period Class
d Year 3 Years 5 Years 7 Years 10 Years 15 Years 20 Years

ost
em 1 .3333 .2000 .1429 .1000 .0500 .03750
2 .4445 .3200 .2449 .1800 .0950 .07219
10/11/233 .1481 .1920 .1749 .1440 .0855 .06677 26
4 .0741 .1152 .1249 .1152 .0770 .06177
4 10,000 21.22 212,242 13.31 133,100
5 6,000 21.65 129,892 14.64 87,846
Price rises at 2% per year. Unit cost rises at 10% per year. Reported prices and costs (columns 3 and 5) are rounded to two
Depreciation (’000)
digits after the decimal. Sales revenues and operating costs (columns 4 and 6) are calculated using exact, i.e., nonrounded, prices
and costs.
Recovery Period Class Acquisition cost:

Year 3 Years 5 Years 7 Years 10 Years 15 Years 20 Years $100,000
ost
m 1 .3333 .2000 .1429 .1000 .0500 .03750
2 .4445 .3200 .2449 .1800 .0950 .07219
3 .1481 .1920 .1749 .1440 .0855 .06677
Year Rate Dep.
4 .0741 .1152 .1249 .1152 .0770 .06177
5 .1152 .0893 .0922 .0693 .05713
6 .0576 .0892 .0737 .0623 .05285 1 .2000 20
7 .0893 .0655 .0590 .04888
8 .0446 .0655 .0590 .04522
2 .3200 32
9 .0656 .0591 .04462
10 .0655 .0590 .04461
3 .1920 19.2
11 .0328 .0591 .04462
4 .1152 11.52
12 .0590 .04461
13 .0591 .04462 5 .1152 11.52
14 .0590 .04461
15 .0591 .04462
16 .0295 .04461
17 .04462
18 .04461
19 .04462
20 .04461
21 .02231
Depreciation is expressed as a percentage of the asset’s initial cost. These schedules are based on the IRS Publication 946,
entitled How to Depreciate Property. Details of depreciation are presented later in the chapter. Three-year depreciation actually
carries over four years because the IRS assumes the purchase is made in midyear.
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projections of cash flow. The data in Table 6.1 are all that are needed to calculate the
(7) Total cash flow of investment −260.00 −6.32 −8.65 3.75 192.98
[(1) 1 (4) 1 (6)]
Income:
(8) Sales revenues $100.00 $163.20 $249.70 $212.24 $129.89
(9) Operating costs −50.00 −88.00 −145.20 −133.10 −87.85
(10) Depreciation −20.00 −32.00 −19.20 −11.52 −11.52
(11) Income before taxes $ 30.00 $ 43.20 $ 85.30 $ 67.62 $ 30.53
[(8) 1 (9) 1 (10)]
(12) Tax at 34 percent −10.20 −14.69 −29.00 −22.99 −10.38
Chapter 6 Making Capital Investment Decisions 177
(13) Net income $ 19.80 $ 28.51 $ 56.30 $ 44.63 $ 20.15
Table 6.4 Incremental Cash Flows for the Baldwin Company ($ in thousands)
*We assume that the sale price of the bowling ball machine at year 5 will be $30 (in thousands). The machine will have been depreciated to $5.76 at that time.
Therefore, the taxable gain from the sale will be $24.24 (5$30 2 $5.76). The aftertax salvage value will be $30 − [.34 3 ($30 − $5.76)] 5 $21.76.
Year 0 Year 1 Year 2 Year 3 Year 4 Year 5
(1) Sales revenue [Line 8, Table 6.1] $100.00 $163.20 $249.70 $212.24 $129.89
(2) Operating costs [Line 9, Table 6.1] −50.00 −88.00 −145.20 −133.10 −87.85
(3) Taxes [Line 12, Table 6.1] −10.20 −14.69 −29.00 −22.99 −10.38
(4) Cash flow from operations [(1) 1 (2) 1 (3)] 39.80 60.51 $ 75.50 $ 56.15 $ 31.67
(5) Total cash flow of investment [Line 7, −$260.00 −6.32 −8.65 3.75 192.98
Table 6.1]
06_171-207.indd 175 24/08/12
(6) Total cash flow of project [(4) 1 (5)] −260.00 39.80 54.19 66.85 $ 59.90 $224.65
NPV @ 4% $123.64
10% $ 51.59
15% $ 5.47
15.68% $ 0.00
20% ($ 31.35)
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inflows over the life of the project. Third, plant and equipment are sold off at the end
Faculty of Finance

q Nominal cash flows: refers to the actual dollars to be
received or paid out.
q Real cash flows: refers to the cash flow’s purchasing
power
q Nominal cash flows must be discounted at the nominal
rate
q Real cash flows must be discounted at the real rate
(1+ Nominal rate) = (1+ Inflation) * (1+ Real rate)
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Cash flow 0 1 2
-$1,000 $600 $650
Shields Electric forecasts the nominal cash flows on a

particular project as above. The nominal discount rate is
14%. The inflation rate is forecast to be 5%. What is
the value of the project?
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Faculty of Finance

Use Nominal cash flow:
Cash flow 0 1 2
-$1,000 $600 $650
NPV =
-1,000 + 600/(1+14%) + 650/(1+14%)^2 =
$26.47
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Faculty of Finance

Use Real cash flow:
Cash flow 0 1 2
Nominal -$1,000 $600 $650
Real -$1,000 600/(1+5%) 650/(1+5%)^2
Real discount rate = 8.571%

NPV = -1,000 + 571.43/(1+8.571%) +
589.57/(1+8.571%)^2 = $26.47
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4.2 Investment Evaluation Techniques
Independent projects
• An independent project is the project, which the acceptance

or rejection of this project does not affect the acceptance/rejection
of other projects of a firm.
Projects • The independent projects satisfying capital budgeting criteria are accepted
Mutually exclusive projects
• Mutually exclusive projects is a set of projects

with more than one project satisfying the capital budgeting criteria
• However, only one project can be accepted
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o The Net Present Value (NPV) is the difference between the present
value of a project’s future cash flows and the cost of the project.
o Define the NPV rule:
ü For independent projects, projects with NPV >0 should be selected
ü For mutually exclusive projects, select a project with the highest positive NPV
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Faculty of Finance
4.2.1 The Net Present Value (NPV) – Example 1

Firm X is considering a project with expected CF as following:
Unit of measure: m. VND
Year 1 Year 2 Year 3 Year 4 Year 5
CF 1,000 1,000 2,000 2,500 2,500
The initial investment of this project is VND 5,000 m.. Supposing that everything goes
as expected. If the firm uses the discounted rate at 10%, is this project good?
The present value of the future CF of this project:

= 1000/(1+10%) + 1000/(1+10%)2 + 2,000/(1+10%)3 + 2,500/(1+10%)4 +
2,500/(1+10%)5 = VND 6,498 m.
NPV = 6,498– 5,000 = 1,498 m >0

Hence, firm C should accept this project
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q Advantages:
q NPV uses cash flows, not earnings
q NPV uses all the cash flows of the project while other
approaches ignore CFs beyond a particular date
q NPV discounts the cash flows properly
q Disadvantages:
q Based on estimated cash flows
q Sensible approach
q In case of limited fund, only NPV does not allow firms
to compare two projects with unequal lives
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Projects with unequal lives

Year
0 1 2 3 4
Project
A (100) 80 80
B (100) 50 50 50 50
1 - (1 + 10% )
-2
NPV A = 80 ´ - 100 = 138,8 - 100 = 38,8
10%
1 - (1 + 10% )
-4
NPVB = 50 ´ - 100 = 158,5 - 100 = 58,5
10%
NPVA <NPVB >> should we choose B???
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Projects with unequal lives

Year
0 1 2 3 4
Projects
A (100) 80 80
A’ (100) 80 80
A + A’ (100) 80 (20) 80 80
1 - (1 + 10% )
-4
100
NPV(A+ A/ ) = 80 ´ - [ 100 + ] = 71
10% (1 + 10%)2
NPVB = 58.5
NPV(A+ A’) > NPVB >>> A should be chosen
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4.2.2 The Payback Rule
o The payback period is the length of time required for accumulated
cash flows produced by an investment to recover the original cash
outlay.
o To answer the question of how long does it take a project to generate
the CF that can recover the initial cost.
o For independent projects, all projects with payback period shorter than
the cutoff date are accepted.
o For mutually exclusive projects, a project with the shortest payback
period (shorter than the cutoff date also) should be selected.
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Faculty of Finance
4.2.2 The Payback Rule – Example 3
Firm Y is considering three proposed projects and use the payback method to evaluate
the projects. The company uses a period of 3 years as its cutoff. The project A, B, and C
generates the following cash flows:
Year Year 0 Year 1 Year 2 Year 3 Year 4 Year 5
Project A -150 60 50 50 40 30
Project B -150 60 50 50 400 420
Project C -150 50 50 75 40 30
o How many years does the company has to wait until the accumulated CF from
these projects are equal or exceed the initial investments?
o Will Firm Y accept or reject these projects?
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o We calculate the payback period for the project A
Year Cash flows Cumulative cash

flows
0 -150 - 150
1 60 - 90
2 50 - 40
3 50
4 40
5 30
o The payback period of the project A = 2 + (40/50)*12 = 2 years 9.6 months
o The payback period of the project B: 2 years 9.6 moths
o The payback period of the project C: 2 years 8 months
o If 3 projects are independent, Firm B should choose 3 projects
o If 3 projects are mutually exclusive, Firm B should choose the project C
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4.2.2 The Payback Rule
o Advantages:
* Simple calculation and easy to understand
*It provides an insight into risk: the shorter payback, the less risk
*It can be useful as supplementary information, can be used to evaluate
smaller projects and is appropriate for firms with liquidity concerns.
o Disadvantages:
*This method ignores cash flows beyond the cut-off date. Thus, this
leads to reject profitable long-term investment.
*No consideration of the time value of money Discounted
*The selection of cut-off period is controversy Payback
Period
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• No consideration of TVM (Timing of cash flow within payback period)

??? Should we choose A or B
• Based on Payback period
• Based on NPV
• Ignores cash flows beyond the cut-off date
??? Should we choose B or C
• Based on Payback period
• Based on NPV
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Faculty of Finance
4.2.3 Discounted Payback Period – Example 3 (cont)
We calculate the discounted payback period for the project A with discounted rate 10%
Year Discounted Cash Cumulative

flows discounted cash flows
0 -150 - 150
1 60/(1+10%) = 54.54 - 95.46
2 50/(1+10%)2=41.13 - 54.33
3 50/(1+10%)3 = 37.55 -16.78
4 40/(1+10%)4=27.32
5 30
o The DDP of the project A = 3 + (16.78/27.32)*12 = 3 years 7.4 months
o The DDP of the project B: 3 years 0.73 moths
o The DDP of the project C: 3 years 3.02 months
o If 3 projects are independent, Firm B should reject 3 projects
o If 3 projects are mutually exclusive, Firm B should reject the 3 projects
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Faculty of Finance

o The IRR of an investment is the discount rate that makes the NPV of
the investment equal to zero.

!
!"!
!"# = − !"! = 0
(1 + !"")!
!!!
o The IRR rule: If IRR is higher than the required rate of

return/cost of capital => should accept the project
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Faculty of Finance

o How to calculate the IRR of an investment?
ü Calculate two NPVs, one is positive (NPV1 at r1), one is negative (NPV2
at r2)
ü 1st approach: Apply the formula for IRR:
NPV1
IRR = r1 + (r2 - r1 )
NPV1 + NPV2
2nd approach: Trial and Error
3rd approach: Using spreadsheet or financial indicator
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Faculty of Finance
4.2.4 The Internal Rate of Return (IRR) – Example 5

Firm D is considering a project with expected CF as following:
Year 1 Year 2 Year 3
CF 100 100 100
The initial investment of this project is VND 200 million
If the required rate of return is 18%, Should Firm D undertake this investment?
10/11/23 47
r much more trial and error, we find that the NPV of the project is zero whe
discount rate is 23.37 percent. Thus, the IRR
Faculty is 23.37 percent. With a 20 percen
of Finance
ount rate, the NPV is positive and we of
Department would accept it.
Corporate However, if the discoun
Finance
were 30 percent, we would reject it.
lgebraically,
4.2.4 The IRR is the unknown
Internal Rate ofin the following
Return equation:2
(IRR)
$100
________ $100
__________ $100
__________
0 = −$200 +
uation and Capital Budgeting + +
1 + IRR (1 + IRR)2 (1 + IRR)3
igure 5.4 illustrates what the IRR of a project means. The figure plots the NP
function of $100
the discount rate. The curve crosses the horizontal axis at the IRR o
7 percent because this is where the NPV The equals zero. the horizontal axis
curve crosses
should also be clear that the NPV isatpositive for23.37%
the IRR of discount rates below the IR
negative for discount rates above the IRR. If we accept projects like this one whe
NPV
NPV =0 at the discount rate 23.37%

discount rate is less than the IRR, we will be accepting positive NPV project
If the discount rate > 23.37% => NPV <0
s, the IRR$0rule coincides23.37exactly with the NPV rule.
$10.65
If the discount rate < 23.37% => NPV >0
this were all there 10
were20
to30it, the 40
IRR rule would always coincide with the NP
2$18.39 IRR
But the world of finance is not so kind. Unfortunately, the IRR rule and th
Discount rate (%)
V ruleTheare consistent with each other only for examples like the one just discusse
NPV is positive for discount rates below the IRR and
ral problems with
negative for discount thetheIRR
rates above IRR. approach occur in more complicated situations,
c to be examined in the next section.
he IRR in the previous example was computed through trial and error. This
10/11/23 48
labo
Faculty of Finance

Firm D is considering a project with expected CF as following:
Year 1 Year 2 Year 3 Year 4 Year 5
CF 1,000 1,000 2,000 2,500 2,500
The initial investment of this project is VND 6,000 million
If the required rate of return is 14%, Should Firm D undertake this investment?
IRR = 12.68% < 14% => Reject the project
10/11/23 49
Faculty of Finance

Problems with IRR
q For both independent and mutually exclusive
projects
q Investing or Financing
q Multiple Rate of Return
q For mutually exclusive projects
q The scale problem
q The timming problem
10/11/23 50
These cash flows are exactly the reverse of the flows for Project A. In Project B, the
Faculty of Finance
firm receives funds first and then pays out funds later. While unusual, projects of this
type do exist. For example, consider a corporation conducting a seminar where the
participants pay in advance. Because large expenses are frequently incurred at the
seminar date, cash inflows precede cash outflows.
5.2 Investing
Table q The Internal Rate or Financing
of Return and Net Present Value
Project A Project B Project C
Dates: 0 1 2 0 1 2 0 1 2
Cash flows –$100 $130 $100 –$130 –$100 $230 –$132

IRR 30% 30% 10% and 20%
NPV @10% $ 18.2 –$ 18.2 0
Accept if market rate <30% >30% >10% but <20%
Financing or investing Investing Financing Mixture
o In the case of Project A, the firm has $100 cash to invest, it can either (1) accept Project A
or (2) lend $100 to the bank
à should accept Project A if the lending rate is below IRR (30 percent)
à Follow the normal IRR rule
o In the case of Project B, the firm wants to obtain $100 immediately. It can either (1)
_135-170.inddaccept
145 Project B or (2) borrow $100 from a bank. 24/08/12
à should accept Project B if the borrowing rate is above IRR (30 percent)
à10/11/23
Be careful when using the financing type of project since the IRR rule is reversed 51
Faculty of Finance
4.2.4 The Internal

146 Rate
Part II Valuation ofBudgeting
and Capital Return (IRR)
q Investing or Financing
Figure 5.5 Net Present Value and Discount Rates for Projects A, B, and C
Project A Project B Project C
$30
Discount Discount Discount

NPV
NPV
NPV
0
30 rate (%) 30 rate (%) 10 20 rate (%)
2$2
Approaches
2$30 2$100 2 100 when
R
Project A has a cash outflow at Date 0 followed by a cash inflow at Date 1. Its NPV is negatively related to the discount rate.
Project B has a cash inflow at Date 0 followed by a cash outflow at Date 1. Its NPV is positively related to the discount rate.
Project C has two changes of sign in its cash flows. It has an outflow at Date 0, an inflow at Date 1, and an outflow at Date 2.
Projects with more than one change of sign can have multiple rates of return.
Consider our trial-and-error method to calculate IRR:

$130
10/11/23 −$4 = +$100 − _____ 52
1.25
Faculty of Finance

Multiple IRRs occur when a project has more than one internal rate of
return (IRR). The problem arises where a project has non-conventional cash
flow pattern.
Year 0 Year 1 Year 2 Year 3

-$300 m $1,000 m -$ 850 m $ 120 m
10/11/23 53
Faculty of Finance

NPV profile
30,00
20,00
10,00 104,14%; 0,00

0,00
0% 20% 40% 60% 80% 100% 120% 140%
-10,00
11,65%; 0,00
-20,00
-30,00
-40,00
10/11/23 54
Faculty of Finance

Modified IRR (MIRR): The IRR computed on the assumption that intermediate
CFs are reinvested at the hurdle rate – the cost of equity or WACC. This technique
differs from IRR considering the reinvested rate of the project’s Cash flows.
Example: Reconsider a project with the following cash flows. Cost of capital =15%

-$300 m $1,000 m -$ 850 m $ 120 m
IRR = 16.45%
-$300 m. $ 260.87 m. $ 0 m. $ 120 m.
10/11/23 55
If the initial cash flow is positive—and if all of the remaining flows are
Faculty
negative—there can only be a single, unique of Finance
IRR. This result follows from similar
Department
reasoning. Both these cases of change
have only one Corporate
of sign Finance
or flip-flop in the cash
flows. Thus, we are safe from multiple IRRs whenever there is only one sign change
in the cash flows.
General Rules The following chart summarizes our rules:
q Multiple Rate of Return – Decision Rule
Number of
Flows IRRs IRR Criterion NPV Criterion
First cash flow is negative and 1 Accept if IRR > R. Accept if NPV > 0.
all remaining cash flows are Reject if IRR < R. Reject if NPV < 0.
positive.
First cash flow is positive and 1 Accept if IRR < R. Accept if NPV > 0.
all remaining cash flows are Reject if IRR > R. Reject if NPV < 0.
negative.
Some cash flows after first are May be No valid IRR. Accept if NPV > 0.
positive and some cash more Reject if NPV < 0.
flows after first are negative. than 1.
Note that the NPV criterion is the same for each of the three cases. In other words,
NPV analysis is always appropriate. Conversely, the IRR can be used only in certain
cases. When it comes to NPV, the preacher’s words, “You just can’t lose with the stuff
10/11/23 56
I use,” clearly apply.
Faculty of Finance
PV versus IRR Stanley Jaffe and Sherry Lansing have just purchased the rights to Corpo
4.2.4
ance: ThePicture.
The Motion Internal Rate
They will ofthis
produce Return (IRR)
major motion picture on either a small budget
big budget.qHere
The areScale
the estimated cash flows:
Problem
Cash Flow at Cash Flow at NPV

Date 0 Date 1 @25% IRR
Small budget –$10 million $40 million $22 million 300%

Large budget –25 million 65 million 27 million 160
cause of high risk, rate

Discount a 25=percent discount rate is considered appropriate. Sherry wants to ad
25 percent.
e large budget
Sherrybecause
wants tothe NPVthe
adopt is large
higher. Stanley
budget wantsthe
because toNPV
adopt the small budget because
is higher.
R is higher.Stanley
Who is wants to adopt the small budget because the IRR is higher.
right?
Who is right?
he professor uses real money here. Though many students have done poorly on the professor’s exams over the year
student10/11/23
ever chose Opportunity 1. The professor claims that his students are “money players.” 57
Faculty of Finance
PV versus IRR Stanley Jaffe and Sherry Lansing have just purchased the rights to Corpo
4.2.4
ance: ThePicture.
The Motion Internal Rate
They will produce ofthis
Return (IRR)
major motion picture on either a small budget
big budget.qHere
The areScale
the estimated
Problemcash flows:
Chapter 5 Net Present Value and Other Investment Rules 151
Cash Flow at Cash Flow at NPV
For the reasons espoused in the classroom
Date 0 example,
DateNPV
1 is correct.
@25% Hence Sherry
IRR is right.
However, Stanley is very stubborn where IRR is concerned. How can Sherry justify the large budget
Smallusing
to Stanley budget –$10 million
the IRR approach? $40 million $22 million 300%
Large
This budget
is where incremental IRR–25 million
comes in. Sherry 65 millionthe incremental
calculates 27 million
cash flows160
from choos-
ing the large budget instead of the small budget as follows:
cause of high risk, a 25 percent discount rate is considered appropriate. Sherry wants to ad
Cash Flow at Date 0 Cash Flow at Date 1
e large budget because the NPV is higher. Stanley wants to adopt the small budget because
(in $ millions) (in $ millions)
R is higher. Who is right?
Incremental cash flows from −$25 − (−10) = −$15 $65 − 40 = $25
choosing large budget
instead of small budget
he professor uses real money here. Though many students have done poorly on the professor’s exams over the year
This10/11/23
student chartchose
ever shows that the 1.incremental
Opportunity cash
The professor flows
claims his−$15
thatare million
students at Date
are “money 0 and $25 million
players.” 58 at
Faculty of Finance

q The Scale Problem
q Small Budget is acceptable as an independent project
q Whether it is beneficial to invest an additional $15
million to make the large-budget picture instead of
small one?
q IRR = 66.67% > discount rate = 25%
q NPV @25% = $5 million >0
RULE:
- Compare the NPVs of the two choices
- Calculate the incremental NPV from making the large-
budget project instead of small-budget project
- Compare the incremental IRR to the discount rate
10/11/23 59
Faculty of Finance

q The Timming Problem
Project Year 0 Year 1 Year 2 Year 3 Year 4 IRR

X -$60,000 70,000 5,000 4,000 3,000 29.40%
Y -$60,000 5,000 6,000 7,000 9,500 18.89%
NPV 5% 10% 15% 20% 25% 30%

X 17,125 12,823 8,996 14,408 2,477 -324
Y 34,408 19,650 7,804 -1,802 -9,664 -16,155
??? Comparing Project X and Y

• If low discount rate, which project should we favor?
10/11/23 60
• If high discount rate, which project should we favor?
Faculty of Finance

NPV and IRR
60.000,00
50.000,00
40.000,00
30.000,00 14,17%; 9.599,59
20.000,00
10.000,00 29,40%; 0,00
0,00
-10.000,00
0,00% 5,00% 10,00% 15,00% 20,00% 25,00% 30,00% 35,00% 40,00% 45,00%
-20.000,00
18,98%;
-30.000,00
-40.000,00
NPV Project X NPV Project Y
10/11/23 61
Faculty of Finance

Project Year 0 Year 1 Year 2 Year 3 Year 4 IRR

X -$60,000 70,000 5,000 4,000 3,000 29.40%
Y -$60,000 5,000 6,000 7,000 9,500 18.89%
Y-X 0 - 65,000 1,000 3,000 6,500 14.17%
10/11/23 62
Faculty of Finance

APPROACH:
(1) Compare NPVs of the two projects
(2) Compare incremental IRR to discount rate
(3) Calculate NPV on incremental cash flows
10/11/23 63
Faculty of Finance

o The Profitability Index (PI) or benefit/cost ratio, is defined as the ratio
between the present value of the project’s future CFs and the initial cost
of investment. ! !"!
!!! (1 + !)!
!" =
!"!
o If NPV > 0, the PI >1; If NPV < 0, the PV <1
o For independent projects, projects with PI > 1 should be selected
o For mutually exclusive projects, chose a project with the highest PI >1
(be careful with the scale problem)

10/11/23 64
Faculty of Finance

Firm E is considering a project with expected CF as following:
Year 1 Year 2 Year 3

CF 100 200 300
The initial investment of this project is VND 400 m.
If the discounted rate of return is 10%, please answer:
ü Calculate the PI
ü Should Firm E undertake this investment?
10/11/23 65
Faculty of Finance
o The present value of the future CF of this project:
= 100/(1+10%) + 200/(1+10%)2 + 300/(1+10%)3 = VND 481.59 m.
o PI = 481.59 / 400 = 1.2 > 1
o Firm E should undertake this investment
10/11/23 66
Faculty of Finance

q Advantages:
ü Consider the time value of money
ü The connection between cash inflows and cash outlays
ü Be useful in case of limited capital
ü Compare projects with different scales
q Disadvantages:
ü For mutually exclusive projects, this method ignores the scale of an
investment
10/11/23 67
Faculty of Finance
4.2.5 The Profitability Index (PI) – Capital Rationing
q CR is the process of evaluation and selection of investment proposals

with the limitation of capital
q Two types of CR: soft capital rationing and hard capital rationing
q The soft capital rationing (the internal capital rationing) caused by the
inside policies of the firm (e.g., the motivation of managers)
q The hard capital rationing occurs when the external factors limit the
amount of funds a firm can raise in the capital markets (e.g., attitude to
risk of lenders)
q One period CR/single CR refers to the lack of capital at the current
period
q Multiple-period CR is about capital shortage more than one period
10/11/23 68
Faculty of Finance
4.2.5. The Profitability Index (PI)

q For projects that can be divisible
ü Calculating the PI of each project
ü Ranking the projects from the highest to the lowest projects
ü Selecting the projects in descending order of PI until the fund is
exhausted
q For the indivisible projects
ü Calculating the NPVs of the combination of the projects with available
funds
ü Selecting a combination with the highest NPV
10/11/23 69
Faculty of Finance
Capital Rationing – Example

Firm M is considering 5 projects with the total initial investment of 150,000 m VND
Project Initial PV of projected NPV

Investment CFs
A VND (10,000) m. VND 15,000 m. VND 5,000 m.
B VND (20,000) m. VND 27,000 m. VND 7,000 m.
C VND (30,000) m. VND 43,000 m. VND 13,000 m.
D VND (40,000) m. VND 41,000 m. VND 1,000 m.
E VND (50,000) m. VND 53,000 m. VND 3,000 m.
If a budget restriction of VND 80,000 m.; how does the company select project
to invest in when those projects are divisible and not divisible?
10/11/23 70
Faculty of Finance

1. If the projects are divisible
PI ranking Selection until budget upper limitation
Unit of measure: billion VND

Projec PIs Ranking Project C Ranking NPV
t A 10 (1) 5
A 1.5 (1) C 30 (2) 13
B 1.35 (3) B 20 (3) 7
C 1.43 (2) E 20 (4) 3*20/50 = 1.2
D 1.03 (5) Total 80 (5) 26.2
E 1.06 (4)
Firm M should choose A, B, C, and E; the capital for E is VND 20,000 m.
10/11/23 71
Faculty of Finance

2. If the projects are not divisible
Unit of measure: billion VND

Project Capital NPV
A+B+C 60,000 25,000
A+B+D 70,000 13,000
A+B+E 80,000 15,000
A+C+D 80,000 19,000
Firm M should choose A, B, and C with the highest NPV for their combination
10/11/23 72
This is not surprising, given the theoretical advantages of these approaches. Over
Faculty
half of these companies use the payback of Finance
method, a rather surprising result given the
conceptual problems with this approach. of
Department And while discounted
Corporate payback represents
Finance
a theoretical improvement over regular payback, the usage here is far less. Perhaps
companies are attracted to the user-friendly nature of payback. In addition, the
flaws ofWhich methods
this approach, are incompanies
as mentioned are may
the current chapter, using?
be relatively easy
to correct. For example, while the payback method ignores all cash flows after the
Percentage of CFOs Who Always or Almost Always Use a Given Technique
% Always or
Os Almost Always
e Internal rate of return (IRR) 75.6%

Net present value (NPV) 74.9
Payback method 56.7
Discounted payback 29.5
Profitability index 11.9
SOURCE: Figure 2 from John R. Graham and Campbell R. Harvey, “The Theory and Practice of Corporate Finance: Evidence
from the Field,” Journal of Financial Economics 60 (2001). Based on a survey of 392 CFOs.
SOURCE: Figure 2 from John R. Graham and Campbell R. Harvey, “The
Theory and Practice of Corporate Finance: Evidence from the Field,”
Journal of Financial Economics 60 (2001). Based on a survey of 392 CFOs.
10/11/23 73
Faculty of Finance
4.3 Special Cases of DCF

q Cost Cutting Investment
q The issue is whether the cost savings are large
enough to justify the necessary capital expenditure
Diamond Corporation is considering automating some part of an existing processe.

The equipment cost $80,000 to buy and install.
The equipment has a five-year life and is depreciated to 0 on a straight-line basis
It will actually be worth of $20,000 in five years.
The automation will save $22,000 (before taxes) per year by reducing labor
and material costs.
Income tax rate = 34%; Discount rate = 10%
10/11/23 74
Faculty of Finance

q Cost Cutting Investment
enough to justify the necessary capital expenditure
Identify Relevant Cash Flows:

Depreciation = 80,000/5 = 16,000
Annual OCF = 22,000*(1-34%) + 16,000*34% = 19,960
At the end of Year 5:
Salvage value after tax = 20,000*(1-34%) = 13,200
10/11/23 75
ally going on here is very simple. First, the cost savings increase our pretax income
Faculty of Finance
by $22,000. We have to pay taxes on this amount, so our tax bill increases by .34 3
$22,000 5 $7,480. In otherDepartment of Corporate
words, the $22,000 Finance
pretax saving amounts to $22,000 3
(1 − .34) 5 $14,520 after taxes.
4.3 Special
Second, Cases
while the of DCF
extra $16,000 in depreciation isn’t a cash outflow, it does reduce
our taxes by $16,000 3 .34 5 $5,440. The sum of these two components is $14,520 1
q5Cost
5,440 Cutting
$19,960, just as weInvestment
had before. Notice that the $5,440 is the depreciation tax
shield we discussed earlier, and we have effectively used the tax shield approach here.
We can now finish our analysis. Based on our discussion, here are the relevant cash
flows: enough to justify the necessary capital expenditure
Year
0 1 2 3 4 5
Operating cash flow $19,960 $19,960 $19,960 $19,960 $19,960

Capital spending 2$80,000 13,200
Total cash flow 2$80,000 $19,960 $19,960 $19,960 $19,960 $33,160
At 10 percent, it’s straightforward to verify that the NPV here is $3,860, so we should
go ahead and automate.
10/11/23 76
Faculty of Finance

q Setting the Bid Price
q How to go about setting the bid price to avoid the
winner’s curse
Blue Corporation is in the business of buying stripped-down truck platforms
and then modifying them to customer specification for resale.
A local distributor requested bidsfor 5 specially modified trucks each year
for the next four years.
Blue Corporation needs to determine what price to bid per truck.
Suppose the company can buy the truck platform for $10,000 each.
The facilities can be leased for $24,000 per year.
The labor and material cost is about $4,000.
10/11/23 77
Faculty of Finance

q Setting the Bid Price
q How to go about setting the bid price to avoid the
winner’s curse
Initial investment is $60,000. The equipment will be depreciated straight-line to 0 over
4 years. It will be worth about $5,000 at the end of that time.
The company will also need to invest $40,000 in raw materials inventory and other WC
The relevant tax rate = 39%
What price per truck should the company bid if Blue requires 20% on the investment?
10/11/23 78
ment:
one this, our
We start time line
by looking at theis:capital spending and net working capital investment. We
Faculty of Finance
have to spend $60,000 today 4for new equipment. The aftertax salvage value is $5,000 3
$100,000 2 43,050y1.20 5 $100,000 2 20,761 5 $79,239
Department
(1 − .39) 5 $3,050. Furthermore, we haveof
to Corporate
invest $40,000Finance
today in working capital.
e done this,
We will ourback
get this timeinline
four is:years. Year
4.3
We Special
can’t 0 Cases
determine of
1 DCF
the operating cash flow
2 (OCF) just3 yet because we don’t
4 know
the sales price. Thus, if we draw a time line, here is what we have so far:
q Setting the Bid Price Year
−$79,239
0 1OCF
1 1OCF
2 1OCF
Year 3 1OCF
4
0 1 2 3 4
wsuggests,−$79,239 1OCF 1OCF an1OCF 1OCF annuit
Operatingthe
cash operating
flow cash flow
1OCFis now
1OCF unknown
1OCF ordinary
1OCF
r-year annuity
Change in NWC factor 2$for 20 percent, PVIA (.20, 4), is 2.58873,
40,000 so we have
$40,000
ne suggests, the operating
Capital spending cash flow is now an unknown ordinary
2 60,000 3,050annuity
TotalNPV
four-yearcashannuity
flow5 0 factor
−$79,239
5 2$100,000 1 OCF
for 20 percent,
1OCF 3
PVIA 2.58873
1OCF(.20, 4),
1OCFis 2.58873,
1OCF 1so$43,050
we have:
t: NPV 5 0 5 −$79,239 1 OCF 3 2.58873
With this in mind, note that the key observation is the following: The lowest pos-
sible price
that: OCF
we can $79,239y2.58873
5profitably 5 $30,609
charge will result in a zero NPV at 20 percent. At that
price, we earn exactly 20 percent on our investment.
g cashGivenflow Net
this
OCFIncome
needs5to =be
observation,$15,609
$30,609
we =>each
first need
$79,239y2.58873 Sales
to 5 = $134,589
year.
determine
$30,609 what the operating cash flow
itemust be for
finished. Thethe
TheNPV
bid to equal
price
final zero. To do
=problem
$134,589/ 5 this,
is to =find we calculate
$26, 918what
out the present value of the
sales price results i
$43,050
ing cash nonoperating
flow needs cash
to flow
be from
$30,609 the last
each year and
year. subtract it from the $100,000
sh initial
flow investment:
of $30,609. The easiest way to do this is to recall that operatin
quite finished. The final problem is to find out what sales price results in
10/11/23 79
e written as net income plus depreciation
4 (the bottom-up definition)
Faculty of Finance
4.3 Special Cases of DCF – Investment with unequal lives

Firm T requires the rate of return of 10%. Firm T is considering two mutually
exclusive projects A and B:

Criteria Year Year Year Year 3 Year Year Year
0 1 2 4 5 6
Project A -3,000 2,000 2,000 2,000
Project B -4,000 1,500 1,500 1,500 1,500 1,500 1,500
NPV (A) = VND 1,973.70 m.

Project B is more attractive than project A?
NPV (B) = VND 2,532.89 m.
10/11/23 80
Faculty of Finance

q The Equivalent Annual Cost
ü Calculate the NPV of the projects at discounted rate
ü Calculate the EAC for each project as:
EAC = NPV / PVIFA with PVIFA = (1-(1+r)-n)/r
ü Convert to perpetuity EEC/r (when two projects are in different risk
categories and are discounted at different rates)
10/11/23 81
Faculty of Finance
Criteria Project A Project B

NPV@10% VND 1,973.70 m. VND 2,532.89 m.
PVIFA 2.49 4.36
EAA VND 792.65 m. VND 580.94 m.
Conclusion: Firm T should select the project A
10/11/23 82
10/11/23
PI, NPV
AA Cash , IRR
AA Flo ,
AA w
AA s…
AA
83
Faculty of Finance
10/11/23 84
Faculty of Finance
10/11/23 85
Faculty of Finance
SUMMARY
§ This chapter covers different investment decision rules: NPV, IRR,
Payback Period, Discounted Payback Period, PI
§ In the normal case, IRR always reaches the same decision as NPV
§ The flaws of IRR occur in case of multiple rate of return, mutually
exclusive projects with different size or timming cash flows. In such
situation, we need to determine the incremental cash flows and
calculate NPV
§ Capital rationing as the case where funds are limited to a fixed
dollar amount. PI is a useful method of adjusting the NPV
10/11/23 86

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Faculty of Finance

Department of Corporate Finance

o To be able to indicate the relevant cash flows of a project

o To apply different techniques for investment evaluation

o To understand special cases of discounted cash flow analysis

4.1.Project Cash Flows

Excluding Sunk Costs

Considering Opportunity Costs

Taking into account Side Effects

Be careful with allocated costs

4.1.Project Cash Flows

Incremental Cash Flows, Not Accounting Income

4.1.Project Cash Flows

4.1.Project Cash Flows

Incremental Cash Flows, Not Accounting Income

Year 1 Year 2 Year 3 Total

4.1.Project Cash Flows

Incremental Cash Flows, Not Accounting Income

Year 0 Year 1 Year 2 Year 3 Total

4.1.Project Cash Flows

4.1.Project Cash Flows

The answer is NO. The $100,000 is not recoverable and already

4.1.Project Cash Flows

4.1.Project Cash Flows

4.1.Project Cash Flows

Suppose the Innovative Motors Corporation (IMC) is

4.1.Project Cash Flows

The answer is no because some of the cash flow represents transfers

4.1.Project Cash Flows

IMC is also contemplating the formation of a racing team.

4.1.Project Cash Flows

4.1.Project Cash Flows

4.1.1. Determining Cash Flows

The net cash flows

The project life

4.1.1. Determining Cash Flows

OCF OCF OCF OCF OCF

Tax implication relating

The Company investigated the marketing potential of brightly

The bowling balls would be manufactured in a building owned by the

+ Finish recovery at the end of Year 5

(1) (2) (3) (4) (5) (6)

1 5,000 $20.00 $100,000 $10.00 $ 50,000

Price rises at 2% per year. Unit cost risesIncrease

Recovery Period Class

d Year 3 Years 5 Years 7 Years 10 Years 15 Years 20 Years

Recovery Period Class Acquisition cost:

4.1.Project Cash Flows

(1+ Nominal rate) = (1+ Inflation) * (1+ Real rate)

4.1.Project Cash Flows

Shields Electric forecasts the nominal cash flows on a

4.1.Project Cash Flows

4.1.Project Cash Flows

Real discount rate = 8.571%

• An independent project is the project, which the acceptance

Mutually exclusive projects

• Mutually exclusive projects is a set of projects

4.2.1 The Net Present Value (NPV)