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CAPITAL BUDGETING TECHNIQUES
PRESENTER: NGUYEN NGOC HANH
ID : MA0N0219
Contents
IRR ( INTERNAL RATE OF RETURN)
NPV ( NET PRESENT VALUE)
CASE
CONCLUSION
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IRR
Definition: is the discount rate that
generates a zero net present value for
a series of future cash flows. This
means that IRR is the rate of return
that makes the sum of present value
of future cash flows and the final
market value of a project (or an
investment) equal its current market
value.
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IRR (Cond’t)
Formula:
CF0 + CF1/ (1+r)1+ CF2/ (1+r)2+ CF3/ (1+r)3+…+
CFn/ (1+r)n = 0
Where:
IRR : denoted by ‘r’
CF: cash flow
If IRR > = r Accept the project
If IRR < r Reject the project
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IRR (Cond’t)
The advantage :
- The target IRR is used to describe the
attractiveness of the project because the IRR is an
indicator reflects the profitability of the project,
one hand it expresses the interest rate that the
project brings on invested capital, on the other
hand it shows the maximum interest loan rate
which the project can accept it.
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IRR (Cond’t)
Disadvantage:
- The application of this criterion may not be
accurate if the account exists to balance negative
cash flows (NCF) significantly during project
operation. At that time the project’s NPV will
change sign several times when it discounted at
various discount rates and whenever it changes
mark leads to a different IRR was determined that
we do not know what is the proper value for the
assessment
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NPV
NPV is the sum present value of the net income
that the project brings in its life cycle. In other
words, NPV is used in capital budgeting to analyze
the profitability of an investment or project.
Formula :
NPV = ∑Ct/ (1+r)t – C0
- If NPV > = 0 Accept the project
- If NPV < 0 Reject the project
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BULLOCK GOLD MINING
Seth Bullock, the owner of Bullock Gold Mining,
is evaluating a new gold mine in South Dakota.
Dan Dority, the company’s geologist, has just
finished his analysis of the mine site. He has
estimated that the mine would be productive for
eight years, after which the gold would be
completely mined. Dan has taken an estimate of
the gold deposits to Alma Garrett, the company’s
financial officer. Alma has been asked by Seth to
perform an analysis of the new mine and present
her recommendation on whether the company
should open the new mine.
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BULLOCK GOLD MINING
Alma has used the estimates provided by Dan to
determine the revenues that could be expected
from the mine. She has also projected the expense
of opening the mine and the annual operating
expenses. If the company opens the mine, it will
cost $ 725 million today, and it will have a cash
outflow of $80 million nine years from today in
costs associated with closing the mine and
reclaiming the area surrounding it. The expected
cash flows each year from the mine are shown in
the table. Bullock Mining has a 12 percent
required return on all of its gold mines.
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BULLOCK GOLD MINING
Year
0
1
2
3
4
5
6
7
8
9
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Cash Flow
-$725,000,000
90,000,000
135,000,000
180,000,000
245,000,000
232,000,000
170,000,000
120,000,000
95,000,000
-80,000,000
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BULLOCK GOLD MINING
1.Construct a spreadsheet to calculate the internal rate
of return (IRR) and net present value (NPV)
NPV = $ 28,373,022 > 0
IRR = 13% > r = 12% (required return)
2.Based on the analysis, should the company open the
mine?
→ The project is high economic effective and is
accepted.
In other words, the company should open the mine.
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CONCLUSION :
The IRR is the discount rate that makes the
estimated NPV of an investment equal to zero; it is
sometimes called the discounted cash flow (DCF)
return. The IRR rule is to take a project when its
IRR exceeds the required return. IRR is closely
related to NPV , and it leads to exactly the same
decisions as NPV for conventional, independent
projects.
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CONCLUSION (Contd’)
When project cash flows are not conventional ,
there may be no IRR or there may be more than
one. More seriously, the IRR can not be used to
rank mutually exclusive projects; the project with
the highest IRR is not necessarily the preferred
investment.
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