Multiple and no IRR PDF

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Multiple and no IRR...

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Multiple and no IRR When does a project have multiple or no IRR? In this situation, how do we make capital budgeting (investment decision)? We have multiple or no IRRs when the project has non conventional cash flows that is if multiple sign changes are there or there are mutliple inflows and outflows during the life of the project. In this case we use other capital budgeting technique such as NPV Multiple IRRs occur when a project begins with inflows but sometime after that a cash outflow occurs resulting in the change of cash flows to occur more than once. Otherwise know as a nonnormal cash flow, resulting in multiple IRRs. When this occurs we make capital budgeting by using the net present value (NPV) to and determine the project based on the NPV. A project having multiple IRR's would display on a graph with the NPV and discount rate % intersecting at multiple points. Interestingly enough, projects with no IRR could have good investments and a positive NPV still, but not have not have a conventional cash flow making a mathematical equation display no IRR. A project may have multiple IRRs if it has nonnormal cash flows. Nonnormal cashflows occur when cash outflows occur after cash inflows have commenced. When this occurs companies could choose to use the MIRR method which is similar to IRR but is based on the assumption that cashflows are invested at the WACC not IRR. This method is a better indicator of the project's true profitability. The MIRR method also eliminates the multiple IRR problem. Multiple internal rate of return occurs when a cash flow of a project change signs more than once. A project is said to have normal cash flows if it has one or more cash outflows followed by a series of cash inflows. An example illustrated in the course book states that a project with non-normal cash flow would be a strip coal mine where the company spends money to purchase the property and prepare the site for mining, has positive inflows for several years, and then the company spends more money to return the land to its original condition. The NPV assumes reinvestment at the WACC, while the IRR assumes reinvestment at the IRR. There are five capital budgeting decision criteria and all are analyzed by computer, making it easy to calculate all five decision criteria. However, NPV is the single best criterion because if provides a direct measure of value the project adds to a shareholder wealth. Multiple IRR occurs when a project has a different set of inflows and outflows in the cash flow line, making difficult and confusing to calculate a single IRR. In addition, IRR is null when there are no conventional cash flows and makes the formula states such result. This is when the NPV proves again to be the best and more effective way for capital budgeting, since at the end

companies are always willing to increase their cash inflows through profitable projects and getting a higher stock price for the benefit of shareholders....