time value of money
MWR
IRR
in order to calculate the net present value (NPV) of a project, an analyst would least likely need to know the:
Internal Rate of Return (IRR) of the project.
If two projects are mutually exclusive
The firm may only choose one and the firm should always choose the project with the highest NPV rather than the highest IRR
If a firm takes on a zero-NPV project, the firm will earn exactly enough to cover the opportunity cost of capital.
The firm will increase in size by taking the project, but shareholder wealth will not change.
Why is the time-weighted rate of return the preferred method of performance measurement?
Money-weighted returns are sensitive to the timing or recognition of cash flows while time-weighted rates of return are not.
The internal rate of return (IRR) method and net present value (NPV) method of project selection will always provide the same accept or reject decision when:
The projects are independent. -If a projects IRR exceeds the cost of capital, the projects NPV will be positive
The only way in which accepting a positive NPV project would reduce firm value is
if its selection precludes selection of a project that would have enhanced firm value to a greater extent (i.e., had a higher NPV). - IRR and NPV method accuracy do not depend upon project duration or costs.
the decision rule for independent projects is as follows:
if the IRR is above the firm's cost of capital, the project should be accepted, and if the IRR is below the cost of capital, the project should be rejected.
The money-weighted return applies the concept of
internal rate of return to investment portfolios.
The time-weighted method
is not affected by the timing of cash flows.
when there are two investment projects that are mutually exclusive
only one can be chosen. If the NPV and IRR are conflicting always use the NPV criteria because it is a more accurate decision criterion
Financial managers should always select the project that provides the highest net present value (NPV) whenever NPV and IRR methods conflict, because maximizing:
shareholder wealth is the goal of financial management.
What is the relationship between the Internal Rate of Return and the Net Present Value
the IRR is the discount rate that makes the net present value equal zero.
Holding Period of Return (HPR)
the change in value of an investment, asset or portfolio over a particular period. It is the entire gain or loss, which is the sum income and capital gains, divided by the value at the beginning of the period.
If the investment period is greater than one year, an analyst must use
the geometric mean to calculate the annual time-weighted return.
The NPV is calculated using
the opportunity cost, discount rate, expected cash flows, and timing of the expected cash flows from the project. -The IRR is not used to calculate the NPV
When a project has a positive NPV, it will add to shareholder wealth because
the project is earning more than the opportunity cost of capital needed to undertake the project.
TWR equation
(1-R1)(1-R2)^1/n -1
Money Weighted return (MWR)
A measure of the rate of return for an asset or portfolio of assets. It is calculated by finding the rate of return that will set the present values of all cash flows and terminal values equal to the value of the initial investment.
Time-weighted Returns (TWR)
A measure of the compound rate of growth in a portfolio
It is possible for NPV and IRR to give conflicting decisions for projects of different sizes.
Because NPV is a direct measure of the change in shareholder wealth, NPV criteria should be used when NPV and IRR decisions conflict.
HPR equation
Return = [dividend + (end − begin)] / beginning price
Geometric Mean Rate of Return
[(1+r1)(1+r2)...(1+rn)]^1/n -1
