NPV AND IRR

Question 1

Explain different scales in NPV

Answer 1

If a project has a positive NPV , doubling its size will result in a double its NPV Too.

Because doubling the cash flows of a project must make it worth twice as much , according to the law of one price

Question 2

Explain the different scales in IRR

Answer 2

IRR measure the average return of the project , so it is affected by the scale of the project.

So we cannot use IRR to compare projects of different scale

Question 3

Explain the key concepts of NPV

Answer 3

We accept a project if NPV >0 and reject if NPV<0.

• look for cash flows
• time period
• investment made
• time value of money because 1k today is worth less in 1 year .

Question 4

Normally we solve IRR FOR ?

Answer 4

We solve the IRR in order to set NPV=0

Question 5

When we accept a project in IRR

Answer 5

When the the R values calculated by IRR is greater than the r provided.

Because shows the return that we need to have in order to make NPV =0

Question 6

NPV vs IRR
Explain what NPV add
Explain what IRR makes

Answer 6

NPV add wealth

IRR shows the rate that makes NPV =0

Question 7

Problems of IRR

Answer 7

• problem with a mix of positive and negative cash flows

- the effect of scale

Question 8

Mutual exclusive projects - explain

Answer 8

So is when we have 2 different projects and we can only choice one !

We choose the project that adds more money and not more percentage, because with IRR we fall in the trap of percentage because IRR does not take into consideration stability. For this reason makes NPV more reliable

Question 9

Give me the definition of NPV

Answer 9

NPV - net present value is the difference between the present value of a cash inflows and the present value of a cash outflows over a period of time. NPV is used in capital budgeting and investments planing to analyse the profitability of a project investment.

Question 10

How NPV is calculate

Answer 10

NPV = nEt=0 rt/(1+i)^t

Rt- net cash inflows

i- discounted rate or rate of return that could be earned in different investments

T- number times period

Example

I=8 %

Investment - 10k

Cf month 1 - 6k
Cf month 2 - 5.5k
T =months 3

Question 11

What a positive NPV indicates ?

Answer 11

Indicate we should accept the project because will be profitable

Question 12

What indicate a negative NPV?

Answer 12

A negative NPV shows that the project should be rejected because will result in a loss. The NPV concept shows that only positive NPV should be consider

Question 13

What is IRR

Answer 13

IRR - internal rate of return is the metric used in capital budgeting to estimate the profitability of potentially investments. The internal rate of return is a discount rate that makes NPV of all cash flows from a particular project equal to zero . IRR calculation relying in the same formula as NPV does.

Question 14

What is the IRR Formula

Answer 14

IRR = NPV(formula)- co =0

Co - total investment cost

We next to solve subject to r

Question 15

How to do the interpretation of IRR

Answer 15

The higher is the R the more desirable is the project , also can be used to rank numerous projects , the higher IRR is the one more desirable. IRR represent is represented in percentage.

If R> r we accept

If R

Question 16

What are the limitation of IRR

Answer 16

Economic of scale ignored- shows that only take into consideration for the percentage gain and not for the actual capital gained.

Ignore the future cost - IRR method only takes into account the project cash flows generated by capital injection and ignores possible future costs that might effect the profitability, which can result in 2 IRR or inexistente IRR

Ignore the reinvestment rates - although IRR allows to calculate the future cash flows , it makes implicit assumption that those cash flows can be re-invested at the same rate as the IRR