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Finance questions

  • 16-12-2011 4:35pm
    #1
    freeze4real
    Registered Users, Registered Users 2 Posts: 2,540 ✭✭✭


    hi guys i am doing some revision for my exams and i am stuck on some questions and I thought i should ask here as i know some could help me.

    when it comes to calculating the internal rate of return for projects.
    One has to first calculate the NPV.

    Then since the IRR must equal zero its theoretical to say its impossible or very hard to calculate by hand so how do one rank 2 projects then with the given number of years and cash out flow.

    I remember my lecturer saying use 2 figures as the discount rate e.g 2% and 45%.

    if i were to use a discount rate of 2% and 45% for two projects with different cash flows do I have to calculate the IRR for both the projects using both the discount meaning i will have to do 4 separate workings ?

    cheers


Comments

  • #2
    soddy1979
    Registered Users, Registered Users 2 Posts: 284 ✭✭soddy1979


    hi guys i am doing some revision for my exams and i am stuck on some questions and I thought i should ask here as i know some could help me.

    when it comes to calculating the internal rate of return for projects.
    One has to first calculate the NPV.

    Then since the IRR must equal zero its theoretical to say its impossible or very hard to calculate by hand so how do one rank 2 projects then with the given number of years and cash out flow.

    It's the other way around. If you discount all cash flows by the IRR the NPV equal to zero. You should however be discounting cash flows by the cost of capital to get a true picture of the NPV.

    I remember my lecturer saying use 2 figures as the discount rate e.g 2% and 45%.

    if i were to use a discount rate of 2% and 45% for two projects with different cash flows do I have to calculate the IRR for both the projects using both the discount meaning i will have to do 4 separate workings ?

    Taking into account my point above, yes you would need to make four calculations. I am wondering though, is your lecturer referring to the fact that sometimes a project will have more than one IRR - If the project has cash flows that change from negative to positive to negative, it will have two IRRs. Certainly though, you should not base an investment decision solely on the IRR. Again, you need to compare the IRR to the cost of capital.


  • #3
    freeze4real
    Registered Users, Registered Users 2 Posts: 2,540 ✭✭✭freeze4real


    soddy1979 wrote: »
    It's the other way around. If you discount all cash flows by the IRR the NPV equal to zero. You should however be discounting cash flows by the cost of capital to get a true picture of the NPV.

    i am in 2nd year finance class so we have not reached the advanced stages of making investment decisions. In the notes I have we have no IRR so we have to use the trial and error calculation just to make an investment decision.
    soddy1979 wrote: »
    Taking into account my point above, yes you would need to make four calculations. I am wondering though, is your lecturer referring to the fact that sometimes a project will have more than one IRR - If the project has cash flows that change from negative to positive to negative, it will have two IRRs. Certainly though, you should not base an investment decision solely on the IRR. Again, you need to compare the IRR to the cost of capital.

    As I said above we haven't reached the more advanced investment decisions, so as for the investments having two IRR we havent done it but i am sure we are doing it next semester, thats when we use calculations to get the exact IRR where NPV is = 0


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