The following table provides each year's cash flow and the present value of each cash flow. Year Cash Flow Present Value 0 -$500,000 -$500,000 1 $200,000 $181,818.18 2 $300,000 $247,933.88 3 $200,000 $150,262.96 Net Present Value = $80,015.02 Payback = Net Investment Average Annual Net Cash Flow Profitability Index = Present Value of Cash Inflows Present Value of Cash Outflows Profitability Index Rule Accept investments if the Profitability Index is greater than one and reject investments if the Profitability Index is less than one. Internal Rate of Return Internal Rate of Return is the interest rate that makes the Net Present Value zero. 'MODIFIED INTERNAL RATE OF RETURN - MIRR For example, say a two-year project with an initial outlay of $195 and a cost of capital of 12%, will return $121 in the first year and $131 in the second year. To find the IRR of the project so that the net present value (NPV) = 0: NPV = 0 = -195 + 121/(1+ IRR) + 131/(1+ IRR)2 NPV = 0 when IRR = 18.66% To calculate the MIRR of the project, we have to assume that the positive cash flows will be reinvested at the 12% cost of capital. So the future value of the positive cash flows is computed as: $121(1.12)+ $131 = $266.52 = Future Value of positive cash flows att=2 = sqrt($266.52/195)-1 = 16.91% MIRR You can see here that the 16.91% MIRR is materially lower than the IRR of 18.66%. In this case, the IRR gives a too optimistic picture of the potential of the project, while the MIRR gives a more realistic evaluation of the project. The formula for MIRR is: MIRR - FV (PositiveCash Flows.costo fcapital) PV (InitialOutlays Financing Cost) 1 Formula sheet: Return on assets: ROA = Net Income Average Total Assets Return on equity Net Income ROE = Avg Stockholder's Equity Asset turnover Sales Revenue Asset Turnover Total Assets Working capital ratio Working capital = Current assets Current liabilities Quick asset ratio Current Assets - Inventory Current Liabilites Or (Cash + Marketable Securities + Accounts Receivable) / Current Liabilities Net present value C C2 CT NPV = -Co+ + + 1+r (1+r) (1+r)T -Co Initial Investment C = Cash Flow r Discount Rate T-Time Example: $200,000 $300,000 $200,000 NPV = -$500,000+ 1.10 1.10 1.103