Page 431 - Corporate Finance PDF Final new link

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BRILLIANT’S Capital Budgeting 431

Symbolically, the IRR is equal to the value {gå~m°b Ho$ ê$n _| IRR {ZåZ BŠdoeZ _| ‘r’ H$s d¡ë`y
of ‘r’ in the equation: Ho$ ~am~a hmoVm h¡:

CF CF 1 CF 2 CF n SV +WC n
n
CO = + + +........ +
0 0 1 2 n n
(I+r) (I+r) (I+r) (I+r) (I+r)
Where, CO = Cash outflow at time O,
0
CF = Cash inflow at different point of time
1
n = Life of the project and
r = Rate of discount (yet to be calculated)
SV & WC = Salvage value and working capital at the end of the n years.
Acceptance-Rejection Decision ñdrH¥${V-AñdrH¥${V H$m {Z`_
In order to take decision about acceptance {H$gr àmoOoŠQ> H$mo ñdrH¥$V `m AñdrH¥$V H$aZo H$m
or rejection of any capital investment project, {ZU©` boZo Ho$ {b`o JUZm H$s JB© IRR H$s VwbZm [aQ>Z© H$s
the calculated IRR is compared with the re-
dm§{N>V aoQ> go H$s OmVr h¡ {Ogo "H$Q>-Am°\$-aoQ>" `m
quired rate of return which is also known as the "hS>©b aoQ>' ^r H$hm OmVm h¡Ÿ& `{X IRR, H$Q>-Am°\$-aoQ>
'cut-off rate' or 'hurdle rate'. If the IRR is greater
H$s VwbZm _| A[YH$ hmo Vmo àmoOoŠQ> H$mo ñdrH$ma {H$`m Om
than the cut-off rate, the project would be ac-
gH$Vm h¡ AÝ`Wm Bgo AñdrH¥$V H$a XoZm Mm{hEŸ& `{X
ceptable, otherwise it should be rejected. If both
the IRR and the required rate of return are equal, IRR VWm [aQ>Z© H$m dm§{N>V aoQ> XmoZm| g_mZ h¢ Vmo àmoOoŠQ>
the project may be accepted or rejected. H$mo ñdrH¥$V ^r {H$`m Om gH$Vm h¡ `m AñdrH¥$V ^rŸ&
Procedure to Find Out the Value 'r' 'r' H$s d¡ë`y {ZYm©[aV H$aZo H$s à{H«$`m
The specific procedure to find out the value 'r' H$s d¡ë`y àmá H$aZo H$s {d{eï> {d{Y, 'r' H$s _mZr
of ‘r’ implies finding out the net present value JB© Xmo {d{^Þ d¡ë`yO na ànmoOb H$s ZoQ> àoOoÝQ> d¡ë`y H$mo
of the proposal at two different assumed val- àmá H$aZm Xem©Vr h¡ {Og_| IRR Ho hmoZo H$s g§^mdZm hmoVr
ues of ‘r’ within which the IRR is expected to
lie. Thereafter, the two rates are interpolated h¡Ÿ& CgHo$ ~mX, ZoQ> àoOoÝQ> d¡ë`y H$mo eyÝ` Ho$ ~am~a H$aZo
to make the net present value equal to zero. Ho$ {cE XmoZm| Xam| H$s Am§V[aH$ JUZm H$s OmVr h¡Ÿ&
The procedure for the calculation of IRR IRR H$s JUZm H$s à{H«$`m H$mo Xmo AbJ-AbJ
can be explained in two different situations: n[apñW{V`m| _| g_Pm Om gH$Vm h¡:
1. When future cash flows are equal and take 1. O~ â`yMa H¡$e âbmoO ~am~a hmo VWm EÝ`yQ>r Ho$ ê$n
a form of annuity, and _| hmo VWm
2. When future cash flows are unequal. 2. O~ â`yMa H¡$e âbmoO ~am~a Zht hmoŸ&

1. When Future Cash Flows are Equal 1. O~ â`yMa H¡$e âbmoO ~am~a hmo
In case the proposal has only one cash `{X {H$gr ànmoOb _| àma§^ _| H¡$e AmCQ>âbmo Ho$db
outflow in the beginning and the future cash EH$ ~ma hr hmo VWm â`yMa H¡$e BZâbmoO ~am~a hm| Vmo
inflows are equal, the calculation of IRR is rather IRR H$s JUZm AmgmZ hmoVr h¡Ÿ& Bgo {ZåZ{b{IV CXmhaU
simple. This can be explained with the help of
following example: H$s ghm`Vm go g_Pm Om gH$Vm h¡: