NPV AND IRR
Presented by
Abhishek Yadav
&
Utkarsh Gaur
NET PRESENT VALUE METHOD
Cash flows of the investment project should be
forecasted based on realistic assumptions.
Present value of cash flows should be calculated using
the opportunity cost of capital as the discount rate.
Net present value should be found out by subtracting
present value of cash outflows from present value of
cash inflows. The project should be accepted if NPV is
positive (i.e., NPV>0).
CALCULATING NET PRESENT
VALUE
Assume that Project X costs Rs2,500 now and
is expected to generate year-end cash inflows
of Rs900, Rs800, Rs700, Rs600 and Rs500 in
years 1 through 5. The opportunity cost of the
capital may be assumed to be 10 percent.
WHY IS NPV IMPORTANT?
Positive net present value of an investment represents the
maximum amount a firm would be ready to pay for
purchasing the opportunity of making investment,
The net present value can also be interpreted to represent
the amount the firm could raise at the required rate of
return, in addition to the initial cash outlay, to distribute
immediately to its shareholders and by the end of the
projects’ life, to have paid off all the capital raised and
return on it.
ACCEPTANCE RULE
Accept the project when NPV is positive
NPV>0
Reject the project when NPV is negative
NPV<0
May accept the project when NPV is zero
NPV=0
EVALUATION OF THE NPV
METHOD
NPV is most acceptable investment rule for the
following reasons
Time value
Measure of true profitability
Value- additivity
Shareholder value
Limitations:
cash flow estimation
Discount rate difficult to determine
Ranking of projects
INTERNAL RATE OF RETURN METHOD
The internal rate of return (IRR) is the rate that equates
the investment outlay with the present value of cash in
flow received after one period. This also implies that the
rate of return is the discount rate which makes NPV=0.
CALCULATION OF IRR
Un even Cash Flows: Calculating IRR by Trial
and Error The approach is to select any
discount rate to compute the present value of
cash in flows .If the calculated present value of
the expected cash in flow is lower than the
present value of cash outflows, a lower rate
should be tried. On the other hand, a higher
value should be tried if the present value of
inflows is higher than the present value of
outflows. This process will be repeated unless
the net present value becomes zero.
CALCULATION OF IRR
Level Cash Flows Let us assume that an
investment would cost Rs 20,000 and provide
annual cash inflow of Rs 5,430 for 6 years
The IRR of the investment can be found out
as follows
EVALUATION OF IRR METHOD
IRR method has following merits:
• Time value
• Profitability measure
• Acceptance rule
• Shareholder value
IRR method may suffer from
• Multiple rates
• Mutually exclusive projects
• Value additivity
