Question

·How do you calculate Payback Period, Net Present Value (NPV), Internal Rate of Return (IRR), and Modified Internal Rate of Return (MIRR) for a given project and evaluate projects using each method? Explanation and example.

Answer 1

Payback Period: Payback period is the time in which the initial cash outflow of an investment is expected to be recovered from the cash inflows generated by the investment.

Net Present Value (NPV):The net present value (NPV) or net present worth (NPW) is a measurement of profit calculated by subtracting the present values (PV) of cash outflows (including initial cost) from the present values of cash inflows over a period of time. Incoming and outgoing cash flows can also be described as benefit and cost cash flows, respectively

Internal Rate of Return (IRR): Internal rate of return (IRR) is a metric used in capital budgeting to estimate the profitability of potential investments. Internal rate of return is a discount rate that makes the net present value (NPV) of all cash flows from a particular project equal to zero

Modified Internal Rate of Return(MIRR):Modified internal rate of return (MIRR) assumes that positive cash flows are reinvested at the firm's cost of capital, and the initial outlays are financed at the firm's financing cost. By contrast, the traditional internal rate of return (IRR) assumes the cash flows from a project are reinvested at the IRR.