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Group Sia You Gin, Siaw Yang Yew, Tan Juin Hwee, External rate of return…
Group Sia You Gin, Siaw Yang Yew, Tan Juin Hwee
External rate of return (ERR)
Idea of External rate of return
Second step is all inflow are compounded that at the external rate to the end of project.
Third step is to equate the inflow and outflow by compounding outflow at the external rate of return.
If ERR > MARR
The project is :check:
If ERR < MARR
The project is :green_cross:
First step is to discount all the expenses at external rate back to time zero.
External rate of return is another interest rate that used to discount inflow and outflow.
Problem of internal rate of return
It assumes all the profit and revenue will be invested at internal rate of return.
Complexity of cash flow is likely that will have multiple solution to equation. Having more than one internal rate of return is meaningless because it does not help the situation.
Evaluating a single project
External Rate of Return (ERR)
Comparison between IRR & ERR
IRR assumes Reinvestment of Cash Flows
ERR is used when Revenue cannot be reinvested
Steps
Discount All Net Cash Outflow to T=0
Compound All Net Cash Inflow to End of Period, N with External Reinvestment Rate, ε%
Find ERR by discounting PW Outflow such that PW Outflow = PW Inflow
Internal Rate pf Return (IRR)
Evaluating the project
Accept if NPV > 0
Way to determine IRR
Step 1: Set the NPV = 0.
NPV=0 means the wealth that needs to be added are not destroying the firm
NPV = 0 is the breakeven point.
Step 2: Use R instead of r.
Step 3: Solve the equation and determine the R.
Accept if R > r.
Defined as the discount rate that makes NPV = 0
Defined as a nodal rate of return used to work out whether a project is worth taking or not other than internal rate of return.