Calculation of Net Present Value

Calculate the Net Present Value for the following Cash Flows

Year 0 – (20,000)
Year 1 – 95,000
Year 2 – (85,000)
Year 3 - 7,500
Discount Rate 259.76%

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 Defects of Internal Rate of Return

When Absolute values of Cash Outflow & Cash Inflow are

same, IRR will be Zero
When in a Cash Flow Stream, Cash outflow arises more than
once, Two IRRs will be possible for the Cash Flow stream
Modified Internal Rate of Return to be used in such situation
 Discounting Approach
 Reinvestment Approach
 Combination Approach

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MIRR – Discounting Approach

1) All Negative Cash Flows are discounted at required return

Required return is the Minimum Expected Return
(Discounting Rate) from the project

2) Discounted Cash Flows will be added to Initial Cost

Initial Cost is modified to get a single IRR

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MIRR – Reinvestment Approach

1) All Cash Flows (Positive & Negative) are converted to

Future Value (Compounded) of the end year of the project
Future Value = Present Value (1+r)t

2) Cash Flows will be two only. Initial Outflow and End of

Year Cash Flow
Subsequent Cash Flows are modified to get a single IRR

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MIRR – Combination Approach

This method combines both Discounting & Reinvestment

approach

1) All Negative Cash Flows are discounted using required

return to beginning of the project

2) All Positive Cash flows are compounded to end of project

using required return

TSM, Madurai
Mutually Exclusive Projects

Raman is planning to buy a Laptop and having following

options
1) To buy low end version at Rs. 40,000
2) To buy high end version at Rs. 80,000
The Cash Flows are
Low End Version High End Version
Year 0 – (40,000) Year 0 – (80,000)
Year 1 – 30,000 Year 1 – 55,000
Year 2 – 45,000 Year 2 – 75,000
Year 3 - 60,000 Year 3 – 95,000

Discount Rate 12%

TSM, Madurai
NPV & IRR Summary
Cash Flows Net Present Value Internal Rate of Return
Accept if IRR is more
Single Cash Outflow Accept if NPV is Positive
than Required Return
& Multiple Cash
Inflows Reject is IRR is less than
Reject if NPV is Negative
Required Return
Single Cash Inflow & Accept if IRR is more
Accept if NPV is Positive
Multiple Cash than Required Return
Outflows Reject is IRR is less than
(Projects) Reject if NPV is Negative
Required Return
Single Cash Inflow & Accept if IRR is less than
Accept if NPV is Negative
Multiple Cash Required Return
Outflows Reject if IRR is more than
(Loan Repayment) Reject if NPV is Negative
Required Return
Cash Streams with Accept if NPV is Positive Not Valid
more than 1 Cash
Outflows & Inflows Reject if NPV is Negative Not Valid

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Mutually Exclusive Projects – Cash Flow Difference

The Cash Flows are

Project A Project B
Year 0 – (25,000) Year 0 – (25,000)
Year 1 – 4,000 Year 1 – 22,000
Year 2 – 8,000 Year 2 – 7,000
Year 3 - 21,000 Year 3 – 1,000

Discount Rate 12%

IRR is the Best Method when choosing between Mutually

Exclusive Projects

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IRR – Summary

With various demerits, IRR is followed since it gives a single

rate for various comparisons

Decisions are taken by avoiding multiple cash flows

Projects of similar Cash flows are compared

Calculation of Discount Rate is difficult, then we can use IRR

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Capital Rationing

A Company is having 3 projects with following cash flows

(Rs in Lakhs)
Project A Project B Project C
Year 0 – (40) Year 0 – (80) Year 0 – (40)
Year 1 – 30 Year 1 – 55 Year 1 – 34
Year 2 – 45 Year 2 – 75 Year 2 – 38
Year 3 - 60 Year 3 – 95 Year 3 – 42

Discount Rate 12%

Company is having only Rs. 80 Lakhs

Based on Profitability Index the projects are to be ranked.

Based on Ranking, projects are to be chosen

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