Week 2 slides

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Week 2 slides

  1. 1. Calculating Net Present Value, Gross Present Value and Internal Rate of Return
  2. 2. Net Present Value • Net Present Value is the standard technique in investment or project appraisal for deciding whether a project is worth doing – or an investment is worth making • The NPV rule is that: when discounted at the target rate of return, the NPV of the cash flow generated by an investment is not negative, then the project is acceptable. • It is simply the sum of the present values of all cash flows generated by an investment or project • The Gross Present Value is identical to the Net Present Value except that the initial cost is ignored.
  3. 3. Answer five questions, set out the cash flow and discount it 1. 2. 3. 4. 5. How much is paid out? When? How much is received? When? What is the target rate of return?
  4. 4. Hypothetical investment • Cost: £1,000,000 • Income received: £50,000 per annum receivable annually in arrears for five years • Capital received: £1,200,000 in five years • TRR: 10% per annum.
  5. 5. Period 0 1 2 3 4 5 Capital Outlay -£1,000,000 £0 £0 £0 £0 £0 Income £0 £50,000 £50,000 £50,000 £50,000 £50,000 Capital receipt £0 £0 £0 £0 £0 £1,200,000 Net Cash Flow -£1,000,000 £50,000 £50,000 £50,000 £50,000 £1,250,000 PV factor @ 10% 1.0000 0.9091 0.8264 0.7513 0.6830 0.6209 Present Value -£1,000,000 £45,455 £41,322 £37,566 £34,151 £776,152 NPV What is the Gross Present Value? -£65,355
  6. 6. Internal Rate of Return
  7. 7. Internal rate of return • Technically - the Internal Rate of Return is the discount rate at which the Net Present Value is zero. • It is the most important measure of actual or expected investment performance. • Broadly it is the average return (both capital or income) on cash invested expressed as a % per period
  8. 8. Period 0 1 2 3 4 5 Capital Outlay -£934,645 £0 £0 £0 £0 £0 Income £0 £50,000 £50,000 £50,000 £50,000 £50,000 Capital receipt Net Cash Flow PV factor @ 10% Present Value £0 -£934,645 1.0000 -£934,645 £0 £50,000 0.9091 £45,455 £0 £50,000 0.8264 £41,322 £0 £50,000 0.7513 £37,566 £0 £50,000 0.6830 £34,151 £1,200,000 £1,250,000 0.6209 £776,152 NPV £0

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