The Internal Rate of Return According to Berk & DeMarzo (2016), the internal rate of return abbreviated as IRR and also known as the yield on investment refers to the discount rate that equates the NPV (net present value) of the proposed investment to zero (0). That is, the future cash flows of the investment plan equal the initial capital outlay of the project. The technique analyzes an investment plan by comparing the yield on investment to the minimum hurdle rate of a company. Like the NPV method, internal rate of return also puts into consideration the time value of money, where it discounts the future inflows. The procedure relies on the initial cost of the capital that the firm may incur when undertaking a project and the cash proceeds to come up with a reliable and informed decision (accept or reject) concerning the investment plan. When an organization computes and get the IRR for one investment program, it also calculates the IRRs for other proposals for comparison to identify the most valuable option to invest on (Berk & DeMarzo, 2016). Furthermore, an organization needs to compare the IRR of an investment to the average weighted cost of capital (minimum required…
is slightly more advantages as being compared to the IRR method. Both has its own pros and cons; however, the cons of the IRR method weighs heavier and drastically. The heavy catch is that discount rates almost usually change significantly over a period of time, and the IRR method is solely based upon one internal rate of return. Not only that, the basic IRR calculation is completely ineffective when it is evaluating a project with a mixture of multiple positive and negative cash flows. In this…
Managing Investment Growth In order to effectively grow an investment, it is important to analyze risk and diversify securities, to maximize a portfolio to match the goals of the investor. Through analyzing the different classes of risk, one can match investments to an investors risk tolerance and return requirements. While some investments may present greater risk they are countered by a higher rate of return and vice versa, less risk corresponds to a lower return. Moreover, investment risk…
1.5.1.2 TERM STRUCTURE OF INTEREST RATE Mishkin (2009) states that the term structure of interest rate explains that bonds with the same risk and liquidity have different interest rates because the bonds time to maturity are different from each other. He also states that the yield curve illustrates how the returns of bonds and maturity changes over time. There are four approaches that elaborates on the different shapes of the yield curve, they are the expectation, liquidity-premium, segment…
and return tradeoff, where if there is high risk it will compensate with high return as well as the low risk with lower return. The risk can be classified into two types which are systematic (uncontrollable) risk and unsystematic (controllable) risk. The examples of systematic risk are the interest rate risk, inflation risk, foreign exchange risk, country risk, political risk and market risk. Meanwhile, the example of unsystematic risk is business risk, liquidity risk and credit risk. However,…
Sensible Insurance Company is a mid-sized insurance company whose core product is group term life. Group term life is a one-year rate guarantee contract with premium paid monthly. However, Mammoth Mart requested a three-year rate guarantee on the premium. Furthermore, it will pay the entire three yearsâ€™ premium up-front based on its current workforce and salaries, with monthly adjustment based on the fluctuation to the covered salary amount. As you aware, addition of Mammoth Mart will almost…
Takes into account both the timing and the magnitude of cash flows. Disadvantages of NPV: It is uneasy to estimate the discount rate for a long-term period. NPV cannot handle a negative amount in the cash flow other than the initial…
about investing in markets. While they do share some similarities, there are also significant differences one needs to be aware of, such as how the investment works, the outside forces that influence value, liquidity, and the markets where they are traded. It is also important to understand rates of return, so I shall include multiple examples using a stock with and without a dividend component. Stocks are probably the most easily understood by the novice investor and are a market that is…
Capital market theory is a description and the prediction of the progression of the capital. Capital market theory is used to measure the returns wanted by investors and the intrinsic risks involved; it is model that is used to price assets and most commonly used is to price shares. It is most definitely important response to financial judgment making. Besides that, Capital market theory develops a model for all unsafe assets and ads on the portfolio theory. For the development of capital market…
intended to value a company which is expected to grow much faster than a stable firm in the initial period and at a stable rate after that. The three stage or n-stage model is designed to value small companies with growing market. It assumes that the company will grow initially at a high grow rates, then it will follow a transitional period where the growth rate declines and finally a steady state period where growth is…