0:04 hi there welcome along to this kaplan
0:06 master class on investment appraisal my
0:08 name is andrew moer and i'm a tutor at
0:14 so the plan for this short video is to
0:16 run through the main types of investment
0:18 appraisal now just to remind you what
0:20 investment appraisal is about a company
0:22 might be looking to choose which project
0:24 to do so they might have a range of
0:25 different projects that they need to
0:27 decide on or different investments that
0:30 they need to make a decision on and
0:31 we're going to use these techniques to
0:34 decide which of those investments are
0:36 going to be best for shareholders which
0:38 of these are going to really make those
0:39 shareholders happy
0:41 and maximize their wealth which is often
0:43 the aim of financial management to
0:45 maximize shareholder wealth
0:47 so we've got these four techniques we're
0:49 going to look at today the first one is
0:50 called the accounting rate of return
0:53 otherwise known as the arr
0:54 we're then going to move on to this
0:55 thing the payback period
0:57 we're thirdly going to look at npv's the
1:00 net present value and finally we'll look
1:02 at the internal rate of return commonly
1:05 known as the irr so these are the four techniques
1:06 techniques
1:08 now for each one what i'm going to do is
1:09 just give you a quick overview of what
1:11 it's about
1:12 i'm then going to do an example so for
1:14 each one i'll do a little example just
1:16 to give you an idea as to how they work
1:17 and then we're going to look at the
1:19 advantages and disadvantages of each as
1:22 well because in a lot of exams they like
1:24 you to then discuss the method that
1:26 you've used or to consider the
1:28 weaknesses of particular methods so i
1:29 thought it'd be worthwhile just
1:31 recapping the main advantages and
1:33 disadvantages of each as well so you've
1:35 got quite a nice little overview of each
1:36 of these four types of investment
1:38 appraisal by the end of this
1:41 session so this first one the accounting
1:43 rate of return the arr um just be
1:46 careful this is also known as return on
1:49 capital employed roce for a particular
1:51 project um so they do sometimes mix up
1:53 the name but we're going with this thing
1:55 the arr and what this is is the average
1:59 annual profit before interest and tax so
2:02 pbit profit before interest and tax
2:04 divided by the investment that you've
2:06 made in the project now there are two
2:08 ways of dealing with that investment
2:10 which we'll explore in my example in
2:12 just a minute or two
2:13 so all this is doing really is just
2:16 giving you a percentage return
2:18 on your investment so if the answer
2:20 comes out say 15
2:22 what we're saying is this is giving us a
2:24 15 return
2:26 on the investment we made on this
2:29 project so it's a nice simple measure um
2:30 that's widely used a lot of people will
2:33 use this um to compare projects and it
2:34 works nicely of projects of different
2:37 sizes as well
2:39 let's have a quick look at an example
2:40 then so i've just made up some some nice
2:42 easy numbers here we've got this four
2:44 year project we're making the initial
2:47 investment of of 150 scrap of 50 and
2:49 then we've got p bits so profit before
2:51 interest and tax
2:54 of 60 50 80 and 30 across the four years
2:56 of the project now we're often assuming
2:59 in financial management that we're not
3:01 going to earn any returns on our project
3:03 in year zero so year zero is today
3:06 that's when we're buying that machinery
3:08 or investing in this in this particular
3:10 project um immediately up front we then
3:12 assume that we start getting returns
3:14 from that a year later so in year one is
3:16 where we start getting those returns so
3:19 you notice there's not a p bit figure
3:21 in that year because like i say we're
3:22 not going to buy the machine today and
3:24 instantly made loads of money from it so
3:27 we assume that they start a year later
3:29 so if we think about first of all the
3:32 formula says we need the average annual
3:34 profit before interest and tax so all
3:35 i'm going to need to do is take the average
3:36 average
3:39 of these four figures here so i'm just
3:41 going to need to take the average of
3:42 those four figures and hopefully you're
3:44 all okay with averages
3:46 if i just add them up and divide them by
3:48 four and that will give us the average
3:50 annual profit before interest and tax
3:53 so sure enough if i do that um we end up
3:55 with 55 so that's the average
3:58 profit before interest in tax is 55 if
4:00 you add up the four numbers and divide
4:01 them by four
4:03 so that's the top bit of the formula
4:05 that we need that's the average annual p bit
4:06 bit
4:08 what we now need to do is divide it by
4:09 the investment
4:11 as i said there are two ways of doing
4:13 that the the simplest way probably is
4:14 just to divide it by the initial
4:16 investment so firstly what i'm going to
4:20 do is just do 55 over 150 what is that
4:23 as a percentage and if i do that if we
4:25 use the initial investment so 55 over 150
4:26 150
4:29 we end up with 37
4:31 is our average um return so that's the
4:33 accounting rate of return that's the
4:35 percentage return we're getting on our
4:37 investment each year
4:39 now what that doesn't factor in is this scrap
4:40 scrap
4:42 remember we said that we were going to
4:45 sell it for 50 after four years
4:46 we haven't thought about that yet if we
4:48 haven't brought that into it so what you
4:51 can do instead of using the initial
4:53 investment on the bottom of this formula
4:55 you can take the average so what you do
4:58 is you take the average of what you paid
5:00 for it and what you sell it for
5:02 so we buy this thing for 150 but then at
5:04 the end we sell it for 50. so it's only
5:07 really cost us 100 isn't it if you think
5:09 about that it's only really cost us
5:11 sort of halfway in between those two
5:13 things and so what we do is if you do
5:16 150 plus 50 gives you 200 divide that by
5:18 two so we're just taking the average of
5:20 the two things so halfway between what
5:22 we bought bought it for and then what
5:24 we're selling it for at the end um so if
5:27 you do that using the average investment instead
5:28 instead
5:31 so that little bit there is just taking
5:33 the average
5:35 of the two figures so that's a hundred
5:37 you end up with there isn't it halfway
5:38 between what we bought it for and what
5:41 we're selling it for is 100 um and we're
5:42 doing 55 over 100 which obviously gives
5:45 us 55 so um it's a different way of
5:49 doing it and um they in most exams that
5:50 i teach this stuff in they tell you
5:52 which way they want you to do it either
5:54 using the initial investment method or
5:56 the average investment method so you've
5:57 got a couple of ways of dealing with that
5:58 that
5:59 and obviously they do give different
6:03 answers so they would need to specify
6:06 okay so that's the arr a little example
6:07 of of the technique nice and
6:09 straightforward hopefully
6:11 um in terms of good things about this as
6:13 i say it is quick and easy to do
6:15 it does take into account the whole life
6:17 of the project because it's an average
6:18 annual p bit
6:21 we are thinking about the whole life of
6:23 the project which is good um and it's
6:24 also a relative measure which is a
6:27 percent that means it's a percentage um and
6:28 and
6:30 that's good in some ways as we'll see in
6:33 a minute sometimes it's not but it does
6:35 allow you to compare projects and
6:37 investments of different sizes so yeah
6:39 whether this is a 10 million pound
6:42 investment or a 10 000 pound investment
6:43 yeah you'll still be able to compare and
6:45 you'll get something relative out which
6:48 is quite nice for those comparisons um
6:49 um
6:52 however it does use profits this is one
6:54 of the few investment appraisal
6:56 techniques we do that uses profit most
6:58 of the others will use cash flows now we
7:00 don't particularly like using profits
7:02 profits are they're just theoretical
7:03 aren't they they're just an accounting
7:05 thing and it depends on your
7:07 depreciation policy and it depends on
7:08 and revaluations and all sorts of
7:10 different things
7:12 whereas cash flows are much more factual
7:14 you can spend cash you can pay out as a
7:16 dividend so we prefer using cash flows
7:18 and the fact that this uses profit is a weakness
7:19 weakness
7:22 um it ignores the time value of money
7:24 which is that idea of discounting cash
7:26 flows we're saying that
7:30 80 000 in in five years time or whatever
7:32 is still worth 80 000 today
7:34 it's not we aren't discounting things
7:35 yet so it's ignoring the time value of
7:38 money and also these percentages can be
7:40 misleading um so these relative measures
7:43 although they're good for comparisons
7:44 yeah if we're just looking at the
7:46 percentage um saying oh this this
7:50 project's got an arr of 75 you go wow
7:52 that's incredible um but it might be
7:56 that that's because it returns 75 pounds
7:58 on an investment of 100 pounds
8:00 and they think oh actually this is a
8:02 really really small
8:05 low-key project whereas one might have a
8:07 an arr of 60
8:09 which is 60 million on 100 million yeah
8:11 we don't we can't tell the scale of
8:12 things so sometimes these percentages
8:14 don't give the the full story um which
8:17 isn't necessarily the best thing
8:19 so that's your arr the second technique
8:21 i want to look at today is the payback
8:23 period and which again is hopefully a
8:25 nice concept is how long it's going to
8:28 take to pay back the initial investment
8:30 and the answer for this will be in years
8:32 so how many years is it going to take us
8:34 to pay back the initial investment
8:36 which is which again is hopefully a nice
8:39 simple concept
8:41 again gonna do a few numbers um here
8:44 you'll notice this one uses cash flows
8:46 instead of profits so we are looking at
8:48 cash flows rather than profits in when
8:50 we're doing payback period which is um
8:51 which is preferable
8:53 what i've done here is given you the
8:55 investment of 650 i then made up some
8:58 cash flows here 200 250 175 and 300
9:00 across the four years
9:04 i've then added this cumulative row and
9:06 all that is is just keeping track
9:08 of where we're at with this project so
9:11 we spend 6.50 so at year 0 we're
9:14 immediately 650 down
9:16 we then end up with 450 and if what i've
9:18 done there is you start with your 650
9:21 investment if i know then add back 200
9:23 because we're earning 200 in year one
9:25 all i've done is just add
9:28 six the minus 650 i've added on um 200
9:30 and then we've ended up with our our
9:32 450. so i've just added those together
9:33 we're just keeping track of how much
9:34 we've got
9:37 equally even earned back 250 in year two
9:40 so now we're 200 under um in year three
9:43 uh we earned that 175 so now we're 25
9:45 under we're pretty close to breaking
9:46 even there remember we're looking at the
9:49 point at which we get to zero when do we
9:52 break even and then in year 4 we make
9:54 300 so now we're on 275. so hopefully
9:57 you can see that the breakeven point or
9:58 the payback period
9:59 is going to be somewhere between these
10:02 two isn't it because we've gone from
10:05 being under um zero to suddenly we're
10:07 over zero so at some point in between those
10:08 those
10:10 now if we were doing this to the nearest
10:12 whole year you'd just say four years um
10:14 it's taken four years to pay back i know
10:15 we've nearly paid it back after three
10:18 years we're on -25 we're really close
10:20 but we technically we haven't yet so
10:22 we'd have to wait until year four to say
10:24 it's fully paid back
10:27 some questions and and some exams want
10:29 you to go into that little bit more
10:31 detail then and actually say specifically
10:33 specifically
10:34 how many months has it taken us to pay
10:37 it back and if you assume that we earned
10:40 this this 300 back evenly throughout
10:42 year four so it's spread out nice and
10:45 evenly across the year we can guess
10:47 roughly how many months through the year
10:50 we need to get to now we only need 25 to
10:52 break even don't we um so we only need
10:55 25 more to get back to zero so what you
10:57 could say is throughout year four we
11:01 only need to go 25
11:04 over 300 of the way through the year
11:06 to get back to zero so that's a very
11:08 small amount
11:10 so we're going to say the payback period
11:13 will be three years plus 25 over 300 of
11:14 a year
11:16 and if we want to sort of talk in in
11:19 more plain english if we want to turn
11:21 that into months what we'll do is 25
11:23 over 300 times 12
11:26 so that ends up being exactly one month
11:27 now with that you'd always want to round
11:30 up so if it came out as just under a
11:31 month we'd want to call it a month but
11:35 equally if it came out say is 1.2 months
11:37 you'd want to be saying actually we're
11:38 going to round that up to two months
11:40 because if we said one month it wouldn't
11:42 quite have paid itself off yet so you're
11:43 always going to round up with payback
11:46 period always go just beyond where you
11:47 need to be
11:49 just to make sure it's paid off so in
11:51 this situation the payback period ends
11:53 up being three years and one month so
11:55 that's how long it will take to get back
12:00 so let's think about some advantages and
12:04 disadvantages and we're using cash flows
12:06 as we said which we prefer
12:09 nice easy concept to explain to people
12:11 this is how long it's going to take you
12:13 to pay back what you invested in it
12:15 really nice concept so even for
12:17 non-financial managers or people you
12:20 know maybe not even financially minded
12:22 this is a nice one to be able to explain
12:24 and it also links to liquidity now
12:27 liquidity is is all about cash so
12:30 the shorter the payback period
12:32 the better for the company the shorter
12:34 your payback period is the quicker
12:36 you're breaking even
12:38 the better and so it does link to
12:40 getting that cash back into the business
12:43 which um a lot of investors will like um
12:44 because they'll think right we want our
12:46 cash back quickly from this investment please
12:48 please
12:50 now one of the big disadvantages is the
12:52 fact it doesn't consider the whole
12:54 project um because anything beyond that
12:56 payback period once you've got to that
12:57 payback period
13:00 we're done uh with payback period
13:01 there might be cash flows beyond that
13:03 there might be year five year six year
13:05 seven all these cash flows coming in
13:07 it doesn't think about those once you
13:08 get to your break-even point once you
13:10 get to zero
13:14 it is it's it's finished so you might be
13:16 turning away some amazing projects that
13:18 have really big cash flows in the later years
13:19 years
13:20 because you're just looking at the the
13:23 payback period so it's not great from
13:24 that it's not looking at the overall
13:27 profitability of the project it's just
13:28 looking at how long it takes to pay
13:30 itself back um which is yeah maybe not
13:32 the best
13:34 um this method that we've looked at here
13:36 ignores the time value of money as well
13:38 and so that idea of discounting things
13:42 back to their present value um again
13:43 we haven't done that yet there is a
13:45 technique called the discounted payback
13:47 period which does do that um so you just
13:49 have to look out for that which is a
13:51 slight improvement on this method
13:53 and also there's not a clear decision
13:55 yeah the answer is coming out in in
13:57 years isn't it it's saying
13:59 all right your payback period is three
14:01 years and one month in that question we
14:03 just looked at
14:04 well is that should we do the project then
14:05 then
14:08 i don't know um is that a good project i
14:11 don't know i'm not sure so it's not a
14:14 clear decisive yes or no or this is
14:16 risky this isn't it's it's still then up
14:19 to you know to managers and so on to
14:21 decide whether it's worthwhile so it's
14:22 not a really clear-cut black-and-white
14:29 now of all the investment appraisal
14:32 methods we look at um
14:32 um
14:35 mpvs are the best and they are the they
14:37 are all singing all dancing they they
14:39 tick all the boxes a lot of these
14:40 weaknesses we've been discussing get
14:43 fixed using npv's um so they are the
14:46 most thorough most detailed most widely
14:47 used they're brilliant they're really
14:49 good for investment appraisal and
14:51 there's a simple concept it's just the
14:53 present value of all the money you're
14:55 getting in from a project less the
14:57 present value of all the money you're
14:58 spending on the project
15:00 and just to remind you if that ends up
15:02 being positive
15:11 and if it ends up being negative
15:14 you should reject it
15:17 if it's exactly zero by the way that is
15:18 at the break-even point which we'll look
15:21 at shortly but um
15:23 so if it's zero that's the break-even
15:26 point but in simple terms if it's
15:29 positive what that means is your inflows
15:31 are greater than your outflows so yeah
15:33 let's do it it's going to make us money
15:35 whereas if it's negative it's the other
15:36 way around the outflows are greater than
15:38 the inflows it's not worth it and at the
15:40 break-even point your inflows and your
15:41 outflows are the same so it doesn't
15:43 really matter um so that's the decision
15:46 criteria so that's a really nice
15:48 like we said with um payback period not
15:51 a clear decision npvs give you an answer
15:53 at the end it says yes or no shall we do it
15:54 it
15:56 shall we not it's a really really
15:57 clear-cut decision
16:00 so let's have a look at a little example
16:02 um so i'll just get rid of that and
16:03 bring up some numbers so we've got our
16:05 initial investment and we've got our
16:07 cash flows just the same as the payback
16:08 example then um
16:09 um
16:11 what i've then done is discount those
16:14 cash flows using a discount rate of 10
16:15 um so these are what we call the
16:19 discount factors one 0.909 826 751 and 683
16:21 683
16:23 you can get those often in most exams
16:25 you'll get given some tables that give
16:28 you your discount factors so how to turn
16:30 those cash flows into their present
16:32 values so just to remind you for example
16:34 what this is doing is it's saying right
16:37 if we're getting 300 in four years time
16:39 that's not worth 300 today because of
16:41 this time value of money so what i'm
16:42 going to do is discount it using this
16:45 rate of 0.683
16:47 and in today's terms
16:51 that's worth about 205 and so 300
16:53 like pounds or whatever in four years time
16:53 time
16:57 is worth about the same as 205 today so
16:58 we're getting all these things back into
17:01 their present values now as a quick um
17:02 you can use your tables to get those
17:05 discount rates something i like doing
17:07 especially if you're using software in
17:08 this exam which again a lot of
17:11 qualifications are now
17:12 what you can do is you can do a little
17:17 trick which is equals one plus the rate
17:18 uh to the power of which is this little
17:21 shift six
17:29 and so if you do one plus the rate um
17:31 and then that that's the little top hat
17:33 shift six on your keyboard and then do
17:35 minus the year that will work out the
17:37 discount rate for you so for example here
17:41 that would be
17:45 equals one plus ten percent
17:47 to the power of
17:49 minus and then i click on that cell there
17:51 there
17:52 and so that would be minus zero in this
17:55 situation and that would give you one um
17:57 and then if we do year one um it will be
17:59 you'll do it to the power of minus one
18:01 so that'll give you 0.909 etcetera um so
18:02 that's a nice little shortcut and what
18:04 you can do then is just drag that
18:06 formula across and it will just fill in
18:08 your discount rates for you i'm so much
18:11 quicker and that also helps if the
18:13 discount rate isn't in your tables so if
18:15 it's an odd you know if it's 12.3 or
18:18 something um if this will still work you
18:20 can still use it um so that's a nice
18:22 little way to get those discount rates
18:23 right once you've done all that and
18:25 you've got all your present values we
18:26 just need to add them up
18:28 so if you just add up all of these
18:31 present values so the mpv is just the
18:32 sum of those
18:36 which comes out as plus 75. so in this question
18:37 question
18:40 the inflows all those positive numbers
18:42 in year one two three and four
18:44 add those up they are exceeding the
18:47 investment of 650 by 75 and therefore
18:49 it's worth it and that's a really nice
18:50 little way to do it and you should
18:53 always comment on your mpvs um if it's a
18:55 if you can i would say accept the
18:58 project as a positive mpv will increase
18:59 shareholder wealth so that's a nice
19:00 little phrase to
19:02 to use there because it's positive we
19:08 now in terms of good things it's an
19:09 absolute measure and what that means is
19:12 the answer will be in uh pounds or
19:14 dollars or whatever currency you're
19:16 doing your mpv in
19:18 but it tells you
19:19 how much this product is going to make
19:22 you it's quite factual an absolute
19:24 measure is nice this is how much money
19:26 it's going to make us this is by how
19:28 much it will increase shareholder wealth
19:31 rather than a percentage or years which
19:32 are all relative and open to
19:34 interpretation it's much more factual
19:36 which is which is great
19:38 it does take into account every single
19:40 cash flow the whole life of the project
19:43 is taken into account um it does also
19:44 consider the time value of money that's
19:46 another one that's not here on the list
19:48 but it does think about discounting
19:50 things which is good and as we said
19:52 there's that clear accept or reject
19:54 decisions remember if it's positive you
19:56 accept it if it's negative you reject it
19:58 but at the end there's an answer yes we
20:04 now these
20:07 mpvs are really dependent on that cost
20:09 of capital now i just used a discount
20:11 rate of 10 which would be the company's
20:13 cost of capital when you're doing this
20:16 that's that's a whole other masterclass
20:19 now i'm uh recording a a class on the
20:21 cost of capital so that will be
20:23 available as well if you if you need to
20:24 look at that
20:27 that cost of capital is
20:29 based on a lot of assumptions there are
20:31 a lot of things that go into that that
20:34 mean it's a little bit approximate um
20:36 and if you change that in an mpv
20:38 it massively
20:41 can cause the the mpv to change so i use
20:44 10 in the last example if i use 12
20:46 instead for example the mpv would be
20:49 much lower um so there is that reliance
20:51 on that very sensitive to changes in the
20:52 cost of capital
20:55 um it's also quite complex to explain
20:57 especially to people who aren't
20:58 financial managers
21:01 so whereas with payback period you say
21:03 oh yeah it's the time it takes to pay
21:05 back the initial investment great we'll
21:07 get that yeah nice easy concept with
21:08 this you're saying right what i've done
21:11 is i've taken the present value of all
21:14 the forecast cash flows for the next
21:17 four years um i've deducted the present
21:19 value of the outflows forecast for the
21:21 next four years um discounting them
21:23 using the company's cost of capital
21:25 and because the inflows exceeded the
21:27 outflows i think we should go ahead and
21:29 do this project and you can just imagine
21:31 a non-financial manager going what have
21:34 you just said to me um i've got no idea
21:35 what you're on about
21:37 whereas with payback period it's going
21:39 to take three years to pay yourself off
21:41 great i get that um so it's going to be
21:43 quite hard to explain potentially to
21:45 people who who aren't in this
21:47 don't work in this area
21:49 um it does rely on forecasts um
21:52 so yeah we're predicting what sales are
21:53 going to be in four or five years time
21:55 which is which is almost impossible to do
21:57 do
21:58 that's true of all of the investment
22:00 appraisal techniques to be fair um that
22:01 we are there is an element of
22:03 forecasting and guessing what we expect
22:06 to happen but um it feels with mpvs
22:07 we're quite we're a lot more detailed
22:10 with mpv's um so yeah there are a lot of
22:12 forecasts going on in there which which
22:15 again are based on on estimates
22:17 so that's it for mpvs overall brilliant
22:19 method really widely used heavily
22:21 examined in all financial management
22:24 papers um so yeah very very common
22:26 so you need to be all over that and
22:28 again i am actually going to do a
22:30 master class on exam technique of the
22:32 bigger mpvs as well so there is going to be
22:33 be
22:35 more content available from kaplan on
22:38 doing mpvs and a few tips for the bigger
22:39 ones of those
22:41 the fourth and final one i wanted to
22:42 look at in this session though was the irr
22:44 irr
22:46 and that is the discount rate at which
22:49 your mpv is zero
22:52 now in that last question um we with the
22:55 mpvs we i did it at 10 didn't i and the
22:58 mpv came out as plus 75.
22:59 what we're looking at now is what what
23:01 rate would have meant that the npv is
23:04 zero so what i often call this is is is
23:19 so it i think that's actually a nicer
23:21 name for apologies for my
23:23 dodgy writing but the break-even
23:24 discount rate is what i actually prefer
23:27 to to call this um it's the discount
23:30 rate at which your mpv um comes out as a
23:31 zero rather than it being actually a
23:37 so if we look at um this example with
23:38 some cash flows again so it's the same thing
23:40 thing um
23:40 um
23:42 what you can do in
23:45 excel and in a lot of the exam software
23:47 now as well is to use this irr function
23:52 um so if you highlight these cells
23:54 don't worry about the years just just
23:55 those and it's the cash flows it's not
23:58 the discounted cash flows it's the ones
24:00 before you've discounted anything if i
24:03 do equals irr
24:05 uh of
24:06 and click on the left one and drag it
24:09 across that will tell me what the irr is
24:11 and you can try that again try it in
24:13 your exam software but it will work um
24:16 and that comes out as 15
24:17 so if you do it again you can do it in
24:19 excel if you want it does work so equals
24:21 irr just highlight those cells and it
24:23 will tell you what the rr is now there
24:26 is another way of finding the irr which
24:28 is this linear interpolation which involves
24:30 involves
24:33 doing two mpvs so you use a higher rate
24:35 and a lower rate um and there's a
24:36 formula you can use to do that that's a
24:38 lot more approximate it's a lot more
24:40 guesswork and it's a bit it's a bit of a
24:41 faff um so
24:42 so
24:44 again i much prefer if you are able to
24:47 use this in your exam then then i would
24:49 recommend doing it
24:50 so just to prove to you that this is
24:53 right um so we've said right 15
24:56 if we discount this using 15 percent now
24:58 we should get an mpv of zero so just to
25:00 prove it to you um i've done that so
25:03 i've done my 15 discount factors um
25:05 again you could use that little formula
25:06 i showed you earlier or you could use
25:08 tables if you get them um to get those
25:11 15 discount um discount rates
25:14 and if you discount at a 15
25:16 add it all up the npv sure enough comes
25:17 out as zero
25:19 now that's really nice for this company
25:21 to know because they know right at the
25:22 moment their discount rate what was it
25:25 10 we used earlier um we've got a little
25:27 bit of leeway then it can go up all the
25:30 way up to 15 before we break even
25:33 if the company's rate is 16 or 17
25:34 this is going to go into negative
25:36 territory at the mpv and therefore it
25:39 shouldn't be worth doing so 15 is like
25:41 the turning point from it being a good
25:43 project to a bad project
25:46 so it's a really nice point to know
25:50 now in terms of the irr
25:52 it does use cash flows as well which is
25:53 great the whole life of the projects
25:55 taken into account
25:57 and you don't need to know the cost of
25:59 capital this is working out that
26:01 break-even point so it doesn't need a
26:03 cost of capital to be able to calculate it
26:03 it
26:05 so we're not reliant on that which is
26:08 which is quite useful
26:11 unfortunately it can produce either zero
26:14 or multiple answers if you've got
26:16 irregular cash flows so if you've got a
26:18 project where you invest at the
26:19 beginning earn a bit of money then you
26:21 have to invest a bit more then you earn
26:23 a bit more invest and invest earn
26:24 it can
26:26 that can give you
26:28 several different answers for the irr
26:30 which which obviously isn't ideal and
26:32 quite confusing or if it's an amazing
26:34 project it might not have an ir at all
26:36 there might not be one
26:39 so it's not necessarily the clearest cut
26:40 and there is there is something called
26:42 the modified irr which um you may come
26:44 across in later studies which which is
26:46 an improvement on that
26:48 i also think the name is a little bit
26:50 misleading it says
26:52 it's a rate of return it's not really a
26:54 rate of return it's a it's the discount
26:57 rate at which your mpv is zero so if you
26:59 said the irr is
27:01 is is 10 to someone or 15 percent it was
27:03 wasn't it in this one
27:05 all right the internal rate of return of
27:08 uh is 15 on this project they'll think
27:09 okay right that means it's returning us
27:11 15 a year
27:12 that's the accounting rate of return
27:14 really isn't it and that's that's
27:15 something different what this is is
27:18 we're saying if you use 15 as a discount rate
27:19 rate
27:21 then it will break even so it's it's a
27:23 little bit misleading and also again
27:25 it's a relative measure it's a
27:26 percentage um which as we've talked
27:29 about um has its advantages and
27:30 disadvantages but
27:32 means that you don't know exactly how
27:34 much money it's going to make you so
27:35 this should really be used in
27:37 conjunction with the mpv rather than
27:39 instead of so it's a nice thing to do
27:42 side by side so do an mpv and work out
27:48 right that's it for those four
27:50 investment appraisal techniques
27:52 hopefully that's been useful as a quick
27:54 overview of the the main methods that we see
27:55 see
27:56 as i said there are further master
27:59 classes going to be available in terms of
27:59 of mpvs
28:01 mpvs
28:03 and also the cost of capital um as well
28:05 so plenty of other things to help you
28:07 but hopefully that's given you a little
28:10 a bit of a start on investment appraisal
28:11 and i wish you good luck with the studies
