Financial Management

Financial Management

Net Present Value (NPV)

Net Present Value (NPV) is the total net present value of the project. It represents the total value added or subtracted from the organization if we invest in this project (Brealey and Myers. 1996).

Internal Rate of Return (IRR)

Besides determining the Net Present Value of a project, we can calculate the rate of return earned by the project. This is called the Internal Rate of Return. Internal Rate of Return (IRR) is one of the most popular economic criteria for evaluating capital projects since managers can identify with rates of return (Brealey and Myers. 1996). Internal Rate of Return is calculating by finding the discount rate whereby the Net Investment amount equals the total present value of all cash inflows; i.e. Net Present Value = 0. If we have equal cash inflows each year, we can solve for IRR easily (Clark et al, 1989).

Modified Internal Rate of Return (MIRR)

This method re-calculates the IRR, where a specified re-investment rate of return is applied to the received cash flows. This re-investment rate is a rate predicted by management at which cash flows can be re-invested as they come to hand. One of the underlying assumptions of the IRR method is that received cash flows can be re-invested at the IRR. If management feels that this is not likely, then the re-investment rate is applied and the MIRR calculated (Brealey and Myers. 1996). The MIRR outcome is compared against the required rate of return, and the decision is made in the same way as that for the IRR. The MIRR has the same drawbacks as does the IRR, with the added disadvantage of requiring an extra prediction for a future re-investment rate.

Payback

This is a measure of the time taken for the accumulated annual operating ...