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NPV and IRR - Using the BAII Plus

Professional Calculator

Managerial Accounting

Prepared by Diane TannerUniversity of North Florida

Chapter 15

2

Net Present Value (NPV) and Internal Rate of Return (IRR)

Both are capital budgeting methods Both use time value of money concepts Both allow the comparison of future cash flows at

the date the investment is expected to occur NPV

Calculates the dollar value that the cash flows are worth today

IRR Calculates the rate of return that the cash flows

are expected to generate

Net Present Value Method (NPV)Step 1Identify all cash flows of a potential investment Draw a time line and label inflows and outflowsStep 2Discount all cash flows to their present values Use required rate of return (hurdle rate)Step 3Determine the NPV Combine (add/subtract) the PV of cash inflows

with the PV of the outflowsStep 4Accept or reject the proposal

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How to Interpret & Assess NPVIf the NPV is zero

The investment will earn a return equal to the required rate of return. Accept the investment because it earns exactly the minimum return stipulated by management.

If the NPV is positiveThe investment will earn a return greater than the required rate of return. Accept the investment because it earns more than the minimum return stipulated by management.

If the NPV is negativeThe investment will earn a return less than the required rate of return. Reject the investment because it earns less than the minimum return stipulated by management.

4

Internal Rate of Return (IRR)

An alternative to the NPV method The rate of return that equates the present

value of future cash flows to the investment outlay

The rate that generates a zero NPV Useful when

Comparing two or more investments Comparing to the company’s required rate of

return

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Interpret IRR

If the IRR is equal to the RRRThe investment should be accepted because it earns the minimum rate stipulated by management.

If the IRR is greater than the RRRThe investment should be accepted because it earns more than the minimum rate stipulated by management.

If the IRR is less than the RRRThe investment should be rejected because it earns less than the minimum stipulated by management.

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Assume the IRR is 10%......... The investment will generate an annual return of cash flows of 10%.

BAII Plus Professional

• Required for FIN 3403, your next business class

• Contains a number of different financial functions

• Much like a worksheet in Excel® in that it contains cells that hold data

Cash Inflows and Outflows in the BAII

• Amounts inputted stay in the CF worksheet until erased– Even if you turn your calculator off

• Must specify cash flow directions– Cash inflows

• Enter as positive numbers

– Cash outflows • Entered as negative numbers

• Cash flow (CF) worksheet– A stored worksheet/function in the BAII calculator– Used to determine NPV and IRR of a series of future

cash flows

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Frequency Function on BAII Useful when the annual cash flow amount is expected

to be the same numeric amount for multiple years Frequency field appears as F01, F02, etc.

Where F = frequency 01, 02 = the period correlating to the respective cash

flows, e.g., C01, C02, etc. If the cash flow amount you entered is expected to be

the same for two years, change the frequency from 1.00000 to 2.00000

If the cash flow amount you entered is expected to be the same for three years, change the frequency from 1.00000 to 3.00000

Data Input on the BAII Plus Professional • To open the CF

worksheet: Press [CF]• Close and exit from the CF

worksheet: • Press [CF] [2nd] [CPT]

Data Input on the BAII Plus Professional

How to set to 5 decimalsPress [2nd] [Format]The screen will display: DEC 2.00Enter [5]

as the number of decimals places to be displayed

Press [Enter] [2nd] [CPT]

Recommended for ACG 2071

• Default setting = 2 decimal places • Can display up to 8 places

12WD, Inc. is deciding whether to make an investment of $2,000 for a machine that is expected to provide net cash inflows of $500 for year 1, $800 for year 2, and $1,400 for year 3. WD’s required rate of return is 8.3%. Evaluate.

(2000) 500 800 1400

CFO C01 C02 C03

13Ace, Inc. is deciding whether to make an investment of $2,000 for a machine that is expected to provide net cash inflows of $800 per year for 3 years. WD’s required rate of return is 5.1%. Evaluate.

(2000) 800 800 800

CFO C01 C02 C03

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The End

IRR on the BAII Calculator

WD, Inc. is deciding whether to make an investment of $2,000 for a machine that is expected to provide net cash inflows of $500 for year 1, $800 for year 2, and $1,400 for year 3. WD’s required rate of return is 8.3%. Evaluate.

Step 1: Enter the CF worksheet: [2nd] [CF]Step 2: Clear the cash flow worksheet: [2nd] [CE/C]

The screen will display CF0 = 0.0000Step 3: Input the cash flow for year 0: [2000] [+/-] [Enter]

The +/- key toggles from positive to negative.Step 4: Press [ ]. Input the CF for year 1: [500] [Enter]

continued

IRR on the BAII cont.

Step 5: Press []. Accept the ‘1’ default for FO1 by pressing [] again. Step 6: Input the CF for year 2: [800] [Enter]Step 7: Press [] twice and input the CF for year 3: [1400] [Enter]Step 8: Press [IRR]. Step 9: Press [] [CPT].

Answer = 13.98%

WD, Inc. is deciding whether to make an investment of $2,000 for a machine that is expected to provide net cash inflows of $500 for year 1, $800 for year 2, and $1,400 for year 3. WD’s required rate of return is 8.3%. Evaluate.

NPV on the BAII

Step 1: Enter the CF worksheet: [2nd] [CF]Step 2: Clear the cash flow worksheet: [2nd] [CE/C]

The screen will display CF0 = 0.0000Step 3: Input the CF for year 0: [2000] [+/-] [Enter]

The +/- key toggles from positive to negative.Step 4: Press . Input the CF for year 1: [500] [Enter]

continued

WD, Inc. is deciding whether to make an investment of $2,000 for a machine that is expected to provide net cash inflows of $500 for year 1, $800 for year 2, and $1,400 for year 3. WD’s required rate of return is 8.3%. Evaluate.

NPV on the BAII cont.

Step 5: Press []. Accept the ‘1’ default for FO1 by pressing [] again. Step 6: Input the CF for year 2: [800] [Enter] Step 7: Press [] twice and input the CF for year 3: [1400] [Enter] Step 8: Press [NPV]. At the I= prompt, input 8.3 [Enter] for the interest rate.Step 9: Press [] [CPT]. Answer = $245.91

WD, Inc. is deciding whether to make an investment of $2,000 for a machine that is expected to provide net cash inflows of $500 for year 1, $800 for year 2, and $1,400 for year 3. WD’s required rate of return is 8.3%. Evaluate.

Calculating NPV and IRR• If you need to calculate both NPV and IRR

– Input the cash flows only once• To calculate NPV immediately after you solve

for IRR, perform only steps 8 and 9 of the NPV instructions:– Step 8: Press [NPV]. At the I= prompt, input

8.3 [Enter] for the interest rate.– Step 9: Press [] [CPT]

• To calculate IRR after you solve for NPV, perform only steps 8 and 9 of the IRR instructions:– Step 8: Press [IRR]– Step 9: Press [] [CPT]

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The End