Question

(a) Describe using a suitable example the internal rate of return method of investment appraisal.

(b) Many managers focus on designing a new organizational structure when they want to change culture: is this sufficient?

Answer 1

a]	IRR is that discounted rate for which NPV = 0. It is to be found out by trial and error.
	The discount rate has to be varied suitably till 0 NPV is reached.
	Consider the following project with a life of 3 years. The investment at t0 is $200.
	PROJECT:
	YEAR	CASH FLOW
	0	$           -200.00
	1	$               20.00
	2	$             120.00
	3	$             170.00
	To start with, let us discount the cash flows with 10%.
	YEAR	CASH FLOW	PVIF at 10%	PV at 10%	PVIF at 15%	PV at 15%	PVIF at 19%	PV at 19%	PVIF at 20%	PV at 20%
	0	$           -200.00	1.00000	$            -200.00	1.00000	$       -200.00	1	$               -200.00	1.00000	$        -200.00
	1	$               20.00	0.90909	$                18.18	0.86957	$           17.39	0.84034	$                   16.81	0.83333	$            16.67
	2	$             120.00	0.82645	$                99.17	0.75614	$           90.74	0.70616	$                   84.74	0.69444	$            83.33
	3	$             170.00	0.75131	$              127.72	0.65752	$         111.78	0.59342	$                100.88	0.57870	$            98.38
	NPV			$                45.08		$           19.91		$                     2.43		$             -1.62
	Discounting with 10% gives a positive NPV of $45.08. To reduce the NPV the discount rate should be increased.
	Let us discount with 15%. Now we get a positive NPV of $19.91. So a 5% increase in the discount rate has reduced the NPV by nearly $25. To get to 0 NPV we
	have to increase the discount rate by 20/(25/5) = 4%. Let us now discount with 19%. The NPV is marginally positive. Next let us discount with 20%. We then
	get a marginally negative NPV. So the discount rate for 0 NPV, that is IRR, lies between 19% and 20%.
	By simple interpolation, IRR = 19%+1%*2.43/(2.43+1.62) =	19.60%
b]	Changing the organization structure to change the organizational culture is not going to give the desired result.
	The steps to a change in culture would be:
	*Define mission, vision, values.
	*Evolve business practices to support the target culture
	*Evolve leadership based on organizational culture
	*Educate employees on the target organizational culture
	*Have continuous evaluation and improvement activities
	Changes in organization structure should be only to the extent it will facilitate the above steps.