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NPV and IRR Example

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NPV Example
? Pharmaceutical plant costs $50MM today
? Net cash flows: (no benefit until year 2)
- Year 2: $9MM
- Year 3: $10MM
- Year 4: $11MM
? Assume a no-growth perpetuity after Year 4
? Risk adjusted cost of capita = 14%
? What is NPV?

Internal Rate of Return
? IRR is the break-even rate
? At what rate does the NPV = 0?
? Iterative calculation (many guesses) for calculators
If we know the NPV at 12% is +$5MM, what do we know about the IRR?
If we know the NPV at 12% is -$2MM, what do we know about the IRR?
If we know the NPV at 12% is +$0MM, what do we know about the IRR?

Calculating IRR
? What is the IRR for our pharmaceutical plant? (Higher than 14%!)
? Enter same cash flows, then use IRR to calculate the rate that gives an NPV of 0
? Assume terminal value remains at 78.57

? What is the IRR of our pharmaceutical plant?
? IRR = 23.31%
? No push I to enter 23.31 as the interest rate, then push NPV to give us an NPV of 0 or close.

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Solution Summary

Discussion and computations guide the learner.

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Manal Elkhoshkhany, MBA
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  • MBA, California State University, Sacramento
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