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Acb-III-npv vs. Irr & Multiple Irr
Acb-III-npv vs. Irr & Multiple Irr
Acb-III-npv vs. Irr & Multiple Irr
IRR
Mutually exclusive Multiple IRR
It is important to distinguish between conventional and non-conventional investments while making the comparison between NPV and IRR projects.
CONVENTIONAL INDEPENDENT PROJECTS Non-Conventional Investment A non- conventional investment is one which has cash outflows mingled with cash inflows throughout the life of the project. Non-conventional investments have more than one change in the signs of cash flows. For example : (160000),+1000000, 1000000
A conventional investment is defined as one whose cash flows take the pattern of an initial cash outlay followed by cash inflows. Conventional projects have only one change in the sign of cash flows. For example : (10000),+2500,+4000
NPV PROFILE
15000 10000 NPV 5000 0 0 -5000 DISCOUNT RATE (%) 5 10 15 16 20 25 NPV
Marginal project
Marginal/last project is one which has zero NPV (if NPV method is followed) : NPV=0 IRR equal to required rate of return(if IRR method if followed) IRR=K IRR>k
Lending and Borrowing-type projects Investment projects may be borrowing type or lending type. Let us see the following example-
C1 120 -120
NPV@ 10% 9 -9
NPV
NPV 3 4
OUNT RATE
BORROWING-TYPE PROJECT
PROJECT X
25 20 15 10 5 0 -5 -10 -15 -20
NPV
NPV 10 20 30 40
DISCOUNT RATE
LENDING VS.BORROWING
The IRR rule cannot distinguish between lending and borrowing and hence, a high IRR need not necessarily be a desirable thing. Let us consider project A & B The IRR for project A is 50% and Project B is 75% Project A is attractive project but not project B. This is because Project A involves lending (investing) Rs.4000 @ 50%.B involves borrowing Rs.4000 @ 75% If we go by IRR figures, B appears more attractive than A.
Project C0 C1 IRR NPV@10 %
-4000
+6000
50%
145
+4000
-7000
75%
-236
Multiple IRR (cont.) The formula for finding IRR is : Ct - Co = 0 t=1 (1+r)t In case of conventional investment only one positive value for r exists. In case of non-conventional project, there is a possibility of multiple roots of r. NPV =
n
Project 0 AYea r
Cash flo ws
-1000
4000
-3750
MULTIPLE IRR
DUAL RA
200 0 0 -200 N -400 -600 -800 DI 50 100
URN
150
200 N
UN RA
It is clear that Project A yields dual rate of return @ 50% & 150% At these rates, NPV of the project is zero. At zero rate of discount, the NPV is simply the difference of undiscounted cash flows. As discount rate increases, the negative NPV diminishes and becomes zero at 50%
MULTIPLE IRR
The positive NPV increases as discount rate exceeds 50%, but after reaching maximum it starts decreasing and at 150% it again becomes zero. In case of projects having multiple changes in sign both lending borrowing are involved.
NPV
Multiple IRR (cont..) Although reversal in signs is a necessary condition for multiple IRR, it is not sufficient for such an occurrence. The occurrence of multiple IRR also depends on the magnitude of cash flows. When there are multiple IRRs none of them will work satisfactorily. In such cases, an alternative method must be used. The simple alternative is to use NPV rule.