Chapter 6

331061401.xls

Atrill/Hurley
Financial Management for Decision Makers
Canadian Edition
Chapter 6
General Excel Template
Topic: Net Present Value (NPV) and Internal Rate of Return (IRR)
A central goal in financial management is to undertake those decisions that create
value for shareholders. Therefore, it is of central importance to develop techniques
that enable financial decision makers to identify those investment opportunities that
generate value (as opposed to those that do not).
The capital budgeting techniques of net present value (NPV) and internal rate of
return (IRR) are uniquely designed to accomplish this key organizational objective.

Net Present Value (NPV)

=NPV(rate,value1,[value2],[value3],)
The NPV of an investment is the difference between the measured market value of
an investment (frequently estimated as the present value of the future cash flows
expected from the investment) and the original cost of the investment.
The decision criteria for NPV are as follows:
When NPV is positive, accept the investment.
When NPV is negative, reject the investment.
NPV can also be used to rank multiple mutually-exclusive investments; the
investment with the highest NPV would be the one with the greatest potential value
for shareholders.
Internal Rate of Return (IRR)
=IRR(values,[guess])
The IRR of an investment is that discount rate that generates an NPV of zero (which
would make the financial decision maker indifferent to accepting or rejecting the
investment).
The decision criteria for IRR are as follows:
When IRR exceeds the required return, accept the investment.
When required return exceeds IRR, reject the investment.
IRR and NPV as decision criteria always present the same conclusion for
conventional independent-investment decisions. However, when an investment is
not conventional, IRR may not exist. Also, IRR cannot rank multiple mutuallyexclusive investments.

Copyright 2009 Pearson Education Canada

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Chapter 6

331061401.xls

Suppose your company is attempting to evaluate a particular project with the

following cash flows:

Year
1
2
3
4
5
6
7
8

Cash
Flow
$5,000
$14,000
$12,000
$15,000
$9,000
$12,000
$20,000
$40,000

The project costs $80,000 today and the required return on investments of this type
is 8%. Calculate both NPV and IRR and determine whether or not you should
undertake the project.
NPV

$4,151.66 =NPV(8%,C32:C39)-80000
The NPV calculation is used to determine the present value
of the future expected cash flows from the investment (this
is the measured market value of the investment). By
subtracting the $80,000 cost of the investment, the net
benefit (or loss) of the investment can then be determined.
Particular attention should be paid to the value arguments in
the NPV function. The values that the NPV function
considers begin in period 1. Therefore, cash flows that occur
before then period 1 must be considered separately.
The resulting NPV of the project is positive, indicating that
the project should be accepted since it increases
shareholder wealth.

Copyright 2009 Pearson Education Canada

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Chapter 6

331061401.xls

IRR
Year
0
1
2
3
4
5
6
7
8
IRR

Cash
Flow
-$80,000
$5,000
$14,000
$12,000
$15,000
$9,000
$12,000
$20,000
$40,000

9.08% =IRR(C49:C57)
Unlike the value arguments in the NPV function, the value
arguments in the IRR function begin immediately. As a
result, we can add in the original cost of the project, which
occurs in period zero.
The selection criteria for IRR is "accept a project as long as
its IRR exceeds the required return." Since this project's IRR
of 9.08% exceeds the required return of 8%, the project
should again be accepted.

Copyright 2009 Pearson Education Canada

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