In: Finance
. You will find that there are discrepancies in some of our analysis tools when comparing investments in projects. NPV or discounted Payback, or MIRR are all ways to evaluate whether a project meets our need to be “profitable”, but how should they be used individually or in concert with the others?
Project Number |
1 |
2 |
3 |
4 |
5 |
6 |
7 |
8 |
PVF @10% |
|
Initial Investment |
$2,000 |
$2,000 |
$2,000 |
$2,000 |
$2,000 |
$2,000 |
$2,000 |
$2,000 |
||
Year 1 |
$330 |
$1,666 |
$ |
$160 |
$280 |
$2,200 |
$1,200 |
$(350) |
0.909091 |
|
2 |
$330 |
$334 |
$ |
$200 |
$280 |
$900 |
$60 |
0.826446 |
||
3 |
$330 |
$165 |
$ |
$350 |
$280 |
$300 |
$60 |
0.751315 |
||
4 |
$330 |
$395 |
$280 |
$90 |
$350 |
0.683013 |
||||
5 |
$330 |
$432 |
$280 |
$70 |
$700 |
0.620921 |
||||
6 |
$330 |
$440 |
$280 |
$1,200 |
0.564474 |
|||||
7 |
$330 |
$442 |
$280 |
$2,250 |
0.513158 |
|||||
8 |
$1,000 |
$444 |
$280 |
0.466507 |
||||||
9 |
$446 |
$280 |
0.424098 |
|||||||
10 |
$448 |
$280 |
0.385543 |
|||||||
11 |
$450 |
$280 |
0.350494 |
|||||||
12 |
$451 |
$280 |
0.318631 |
|||||||
13 |
$451 |
$280 |
0.289664 |
|||||||
14 |
$452 |
$280 |
0.263331 |
|||||||
15 |
$10,000 |
$(2,000) |
$280 |
0.239392 |
||||||
Sum of Discounted Cash Flows |
$2,073.09 |
$1,914.55 |
$ 2,393.92 |
$ 2,228.22 |
$ 2,129.70 |
$2,000 |
$ 2,165.04 |
$ 2,182.98 |
||
Discount Profitability Index |
1.0365428 |
0.9572727 |
1.19696025 |
1.11411098 |
1.0648511 |
1 |
1.0825204 |
1.0914922 |
||
Rank |
5 |
Reject |
1 |
2 |
4 |
Accept/Reject |
Reject |
3 |
||
Order of Priority |
3,4,8,5,1,6 |
|||||||||
Rejected Project |
7- Because 7 & 8 are mutually exclusive |
NPV is the net present value of project. It is the difference between discounted cash inflow and cash-outflows.
Discounted pay back is the time when the discounted cash- inflows becomes equal to the initial investment.
MIRR is the modified internal rate of return. It is the rate at which NPV becomes zero and at the same time the cash-inflows are reinvested at a rate.
All methods should be used individually in following cases:
1) NPV: It shows the profitability of the project. It is used as long-term horizon when maximizing profit is the main objective of the firm.
2) Discounted payback: It shows the time of payback. It is used for shorter term horizon when recovering initial investment is the main objective.
3) MIRR: When opportunity cosyt of capital is relevant and higher, MIRR is used as a best tool to measure project's profibability.
In the given example:
NPV of project 3 is highest but payback is more years. The project is suitable for profit maximizing but in uncertain world and shorter horizon, as per discounted payback, the project is rejected.
In the same way, Project 6 may be rejected on NPV basis, but its payback is much earlier. As per discounted payback, the project should be accepted.