Question

Please explain conventional and nonconventional cash flows in capital budgeting.

Which investment evaluation criteria is the best for unconventional cash flows and why?

Provide a example and apply the NPV, IRR, and MIRR methods to your example.

Answer 1

Conventional cash flows involve one cash outflow at the beginning and subsequent cash inflows. There is only one sign change in cash flows. Non conventional cash flows involve number of cash inflows and number of cash outflows. There are many sign changes in cash flows.

NPV is the best method for unconventional cash flows because unconventional cash flows does not give conflicting  decision
and also shows increase in the value of project which is not shown by IRR or MIRR methods

Cash Flows from a project with initial investment of 750000 and cash inflows of 350000,325000,150000 and 180000 in 4 years at cost of capital of 8%

NPV =PV of cash flows -Investment =-750000+350000/1.08+325000/1.08^2+150000/1.08^3+180000^1.08^4 =72416.50

IRR using financial calculator CF1=-750000;CF2=350000;CF3=325000;CF3=150000;CF4=180000 CPT IRR =15.13%

MIRR = (FV of Cash Inflows/PV of Cash Outflows) ^1/n-1
FV of Cash Inflows = 350000*(1+8%)^3+325000*(1+8%)^2+150000*(1+8%)+180000 =1161979.20
MIRR =(1161979.20/750000)^(1/4)-1= 11.57%