Accounting for Managers: Interpreting accounting information for decision-making

188 ACCOUNTING FOR MANAGERS

Table 12.7 NPV for Project 2

Year Project 2

cash flows

Discount factor

(10%)

Present value of

cash flows

1 35,000 .909 31,815

2 35,000 .826 28,910

3 35,000 .751 26,285

4 35,000 .683 23,905

5 35,000 .621 21,735

Total 132,650

Less: Initial investment 125,000

Net present value 7,650

Table 12.8 NPV for Project 3

Year Project 3

cash flows

Discount factor

(10%)

Present value of

cash flows

1 60,000 .909 54,540

2 60,000 .826 49,560

3 80,000 .751 60,080

4 30,000 .683 20,490

5 30,000 .621 18,630

Total 203,300

Less: Initial investment 200,000

Net present value 3,300

CVA, such that, for example, to be approved a project must have a CVA of 10%
(i.e. the NPV is at least 10% of the initial capital investment).
The second DCF technique is the internal rate of return.

Internal rate of return

Theinternal rate of return (IRR)method determines, by trial and error, the
discount rate that produces a net present value of zero. This involves repeated
calculations from the discount tables on a trial-and-error basis using different
discount rates until an NPV of 0 is reached. The discount rate may need to be
interpolated between whole numbers. Spreadsheet software also contains an IRR
function. The IRR for each project, using the spreadsheet function, is:

Project 1 7.9%

Project 2 12.4%

Project 3 10.7%