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Both of these methods use time value of money calculations. The consideration of the
time value of money allows the comparison of future cash flows on the date the
investment is expected to be made.
Net Present Value (NPV)
The net present value method (NPV) calculates the dollar value that each future cash
outflow is worth today--i.e., in the present. Using the NPV to evaluate a capital
budgeting project involves the following steps:
Step 1. Draw a time line and label all cash inflows and outflows with the respective
amounts. Display inflows as positive amounts, and outflows as negative amounts in
parentheses.
Step 2. Use the BAII plus professional calculator (or Excel) to calculate the NPV of the
cash flows using the company's required rate of return as the discount rate.
Step 2. Use the BAII plus professional calculator (or Excel) to calculate the IRR
of the projected investment.
Step 3. Compare the IRR to the company's required rate of return. Accept or
reject the proposed investment based on the following:
If the IRR is greater than the company's required rate of return, accept
the proposed investment.
If the IRR is equal to the company's required rate of return, accept the
proposed investment.
If the IRR is less than the company's required rate of return, reject the
proposed investment.
When the IRR is used in calculating the NPV, the NPV will be zero. Using the IRR
percentage as the discount rate in the NPV calculation will result in a zero NPV.
Function Modes
Most of the keys on the BAII have two functions--a 'regular' function which is labeled
on the key itself, and a '2nd' function which is labeled just above each key. Pressing
the [2nd] key places a '2nd' symbol in the upper left corner of the display. The [2nd] key
toggles between the regular and the 2nd function mode. Once you are in 2nd function
mode, you can press a key to access any 2nd function, the labels of which are printed
on the calculator just above each key.
Data Entry
Similar to entering data in an Excel worksheet, after you enter each numeric amount
into the BAII worksheet, you must press the Enter key in order to accept and save the
amount. The BAII has arrow keys that enable you to scroll through your entries to
verify the amounts entered. Because the calculator has a continuous memory, any data
entered in a worksheet is saved even when you shut the calculator off.
Conventions
This chapter uses the following conventions when providing directions for keystrokes
on the BAII:
[CF] - Brackets indicate you should press the key with the same name.
e.g., press the [CF] key.
Quit - Blue highlights indicate a '2nd' function found as a label just above
the keys, e.g., press the Quit '2nd' key.
Turn the Calculator On or Off
Press the [On/Off] key to turn the calculator on. Press again to turn off. The calculator
automatically powers off after about 10 minutes.
Be cautious, however, because even if you enter a frequency greater than one period,
the next cash flow display will show as the next numeric period, and will not update the
periods to the actual timing of that next cash flow. For example, if you input three
periods in the F01 field, the field will display 3.00000. When you press the down arrow
key, the next field displayed will be C02, though in fact the Cash Flow worksheet is
expecting the cash flow amount for period 4.
Step 1: Press [CF] [2nd] CLR Work Quit. The display should show: CF0= 0.00000.
Step 2: Type in 60000, then press [+\-] to key in the cash flow in year 0, the payment
purchase price of the truck. Press [+\-] to display as a cash flow (negative amount)
cash flow. Press [Enter].
Step 3; Press the down arrow key to display C01. Type in the cash amount for period
1: 15000, then press [Enter]. Press the down arrow key to display F01. Press the down
arrow key to accept the frequency as '1', and to display C02.
Step 4: Type in the cash amount for period 2: 18000, then press [Enter]. Press the
down arrow key and then the down arrow key again to display C03.
Step 5: Type in the cash amount for period 3: 20000, then press [Enter]. Press the
down arrow key and then the down arrow key again to display C04.
Step 6: Type in the cash amount for period 4: 30000, then press [Enter]. Press the
down arrow key.
Step 7: To compute IRR, press [IRR] then [Cpt]. After a few seconds, the display
should read IRR = 12.73549 which tells you that the purchase is estimated to generate
12.74% return per year.
Step 8: To compute NPV, press [NPV] to display I = 0.00000. Enter the required rate of
return as 8.5 and press [Enter]. Press the down arrow key then press [Cpt] to display
NPV = 6,420.4705. The NPV is $6,420 which tells you that the investment will earn
more than the company's required rate of return of 8.5%.
Based on the output, the purchase of the truck should be made.
This page was last edited on Wednesday December 31, 2014 04:39 PM
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