NPV/IRR

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satyaa

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If a project has cash outflows during its life or at the end of its life:
A) there will be multiple net present values.
B) there will be more than one internal rate of return.
C) there will be a negative modified internal rate of return.
D) one will not be able to calculate the net present value.

Cash inflows (investment) to a project will have negative values and cash outflows (returns) from a project should have positive values (am I correct). If this statement is correct, how to solve the above question.

Do we have Modified IRR in the syllabus? I have not seen them in the Schweser notes

Thanks
 
answer is B. cash inflows always have +ve values, as they are generated from projects, while cash outflows have -ve values(including initial investment and investment required during project). when there are cash outflows during its life or at end of life, the project has non normal cash flows and possibly has multiple internal rate of return. this problem is not associated with NPV but only with IRR.
yes modified IRR is in syllabus. you do find them in schweser notes 2006, though not in much detail.



Edited 1 time(s). Last edit at Thursday, April 13, 2006 at 05:54PM by financegal.
 
u dont have term modified irr in any los. but money weighted return is one of application of irr
to investment portfolio. only for investment portfolio and not projects where beginning value of account and deposits are inflows(+ve) and all withdrawals are outflows(-ve).
 
The answer is (B).
Your below given statement is not correct because Investments are your Cash Outflows hence shown with -ve sign, and Returns against this investments are Cash Inflows hence shown in +ve sign.

In case of outflows in mid of the projects are at any time during the project economic life after some Inflows, there will be Multiple IRR's.

Modified IRR's are covered in our course because in IRR's computation, Cash Inflows are reinvested at the same IRR Discount rate that is the major weakness of the IRR, But in MIRR we discounts the Cash Inflows with the given rate like WACC.
 
Can anyone kindly clarify why will it have multiple IRR. Does it mean multiple IRR considering different IRRs with different time periods in mind?

For example if Cast inflow after every period is +100,+200,+300....so IRR after 2nd period(+200) will differ from IRR after 3rd period (+300). Is this the point being made??

Thanks in advance.

Regards

Vaibhav
 
Answer B

You could use the NPV profile graph to follow through the reasoning leading to this answer. Given that IRR is when NPV=0, it follows that any negative NPV cashflows would lower the profile into negative teritory and any positive NPV would pull it up to positive teritory therefore, following the profile line will yield more than 1 IRR.



Edited 1 time(s). Last edit at Monday, April 17, 2006 at 11:31AM by wingman.
 
Modified IRR is covered in Volume III of the CFA material. Page 79-81.

"There is one other situation in which the IRR approach may not be usable--this is when projects with non-normal cash flows are involved. A project has "normal" cash flows if one or more cah outflows (costs) are followed by a series of cash inflows. If, however, a project calls for a large cash outlflow, either sometime during or at the end of its life, then a project has non-normal cash flows. Projects with non-normal cash flows can present unique difficulties when they are evaluated by the IRR method, with the most common problem being the existence of multiple IRRs."

It goes on, but basically, if your cash flows change direction more than once during your analysis period...you put money out, money comes in, and then you have to put more money out at a later period, you'll have more than one IRR. The HP12C gives multiple IRRs (MIRR). In finance, we were told to look at the IRRs that result from the analysis and pick the one that makes most practical sense.

The TI BAII manual demonstrates the keystrokes on p 45-6, HP12C manual explains on p 192. I like the HP12C just because I've used it for over 20 years but also the manual explains the logic behind the calculations a lot better.

Best of studying!!! and testing. Only 47 more days. YIKES!!!!!!



Edited 1 time(s). Last edit at Monday, April 17, 2006 at 12:52PM by prosandy.
 
Sorry, the information on MIRR is on page 82-83 in Vol III of the CFA material.
 
Hi,

I follow Stalla, and they gave a very simple algebric answer to this issue.

IRR is the rate where NPV = 0. Thus, lets take this simple situation.

Initial outflow = $100,000
CF at end of yr. 1 = $1,000,000. (in-flow)
CF at end of yr. 2 = $1,000,000. (out-flow)

Going by the NPV rule,

100,000 = 1,000,000/ (1+IRR) - 1,000,000/(1+IRR) squared.

Solving the above equation we get two results for IRR 7.873% and 0.123%.

Hope, this helps.
 
hey guys u really rock i got my Multiple IRR funda crystal clear...thnx a lot
 
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