Financial modelling: IRR, MIRR ND PI
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This document discusses and compares three capital budgeting techniques: internal rate of return (IRR), modified internal rate of return (MIRR), and profitability index (PI). It defines each technique, provides their formulas, and lists their advantages and disadvantages. IRR is the discount rate that sets the net present value equal to zero. MIRR accounts for the practical reinvestment rate. PI is the ratio of a project's present value of cash flows to initial investment. Each technique considers the time value of money but they differ in their calculations and how they evaluate projects.
Financial modelling: IRR, MIRR ND PI
- 1. IRR,MIRR AND PI GROUP NO. 13 Presented by- Joel Abraham Easo 18 Vishal Mishra 47 Abhilash Prakash 62 Ravi kumar 108 Roshan kumar 111
- 2. CONTENTS INTERNAL RATE OF RETURN (IRR) FORMULA ADVANTAGES OF IRR DISADVANTAGES OF IRR MODIFIED INTERNAL RATES OF RETURN(MIRR) ADVANTAGES OF MIRR DISADVANTAGES OF MIRR PROFITABILITY INDEX (PI) ADVANTAGES OF PI DISADVANTAGES OF PI
- 3. INTERNAL RATE OF RETURN (IRR) Internal rate of returns is that rate at which the sum of discounted cash inflow equals the sum of discounted cash outflow. In other words it is the rate which discounts the cash flow to zero. IRR is the discount rate (or rate of return) at which the net present value is zero. The IRR is compared to the required rate of return (k). If IRR > k, the project should be accepted
- 4. Cont.. Evaluation of IRR Method. I. Time value. II. Profitability measure. III. Acceptance rule. IV. Shareholder value.
- 5. INTERNAL RATE OF RETURN (IRR) 11 0 n t t t C k C 0 where: = initial cash outlay on project = net cash flow generated by project at time t = life of the project = internal rate of return t C C n r
- 6. ADVANTAGES OF IRR This method considers all the cash flows over the entire life of the project. Cost of capital need not be calculated. Projects having different degrees of risk can easily be compared. It takes into account the time value of money.
- 7. DISADVANTAGES OF IRR It is difficult to understand and use in practice because it involves tedious and complicated calculation. Sometimes it may yield negative rate or multiple rates which is rather confusing. It is applicable mainly in large projects.
- 8. MODIFIED INTERNAL RATES OF RETURN(MIRR) The discount rate at which the Present value of a projects cost is equal to the present value of its terminal value, where the terminal value is found as the sum of the future values of the cash inflows compounded at the firms cost of capital.
- 9. ADVANTAGES I. MIRR is a better and improved for project evaluation. II. As it obviates all the shortcomings of normal IRR and NPV methods. III. It take into consideration the practically possible reinvestment rate.
- 10. DISADVANTAGES MIRR is that it asks for two additional decisions i.e. determination of financial rate cost of capital.
- 11. PROFITABILITY INDEX (PI) Profitability index (PI) is an investment appraisal technique calculated by dividing the present value of future cash flows of a project by the initial investment required for the project. Evaluation of PI Method:- I. Time value. II. Value maximization. III. Relative profitability.
- 12. Cont.. . PV of net cash flows Benefit Cost Ratio Initial cash outlay Decision rule: Accept if benefit–Cost Ratio > 1 Reject if benefit–Cost Ratio < 1
- 13. ADVANTAGES OF PI It consider time value of money. It take into account the cash flow inflows and outflows throughout the economic life of the project. PI ascertains the exact rate of the project.
- 14. DISADVANTAGES OF PI It is difficult to understand interest rate or discount rate. It is difficult to calculate profitability index if two projects having different useful life.
- 15. Thank You…!