M.

comSemester IV
Course Advance Financial Management
Module 1 Investment Decisions (2 credits)

Unit 1: Capital Budgeting

Decisions
Q. 1 What is Capital Budgeting and Current and Future Trends Shaping the
Future of Capital Budgeting ?
Ans Capital budgeting is investment appraisal, which is the process of business planning
investment decisions into long-term investment analysis. They will try to find out whether
expanding operations, acquiring new machinery, or producing a new product is profitable. Such
analysis helps companies decide, as making a wrong decision may hinder the company's future
growth.
1. Data-Driven Decision Making
a. As businesses become data-centric, this will increasingly expand data's role in
capital budgeting. In 2025 and after that, big data analytics will most likely dominate
as the chief input to assess any investment opportunity. Instead of making decisions
based solely on financial metrics, decision-makers will be constrained to consider a
multiplicity of factors, including prevailing market conditions, customer demand,
and competitive dynamics.
b. Data-driven tools will likely help risk quantify more effectively. Ultimately, all these
data sources combine to give a clearer view of potential outputs besides delivering
better results and a clearer view of what might happen with a project's outcomes.
Data can be meshed into real-time capital budgeting processes to make decisions
with the freshest information possible. This will make businesses more agile in
investment strategies.
2. Sustainability and ESG Considerations
a. Environmental, Social, and Governance (ESG) factors have gained increased
importance in capital budgeting decisions. Companies are reviewing how they spend
their capital as investors and customers increasingly focus on sustainability.
Sustainable investing is no longer a niche but a mainstream business.
b. Capital budgeting by businesses in the future will undoubtedly take into account
ESG. This might mean incorporating projects' environmental impact, social
responsibility, and good governance into the investment process. Project
propositions that align with this mindset are likely to be approved since companies
today do not wish to sully their image in the public and regulatory standards.
3. Higher Use of Scenario Analysis and Stress Testing
 a. Capital budgeting would consider the volatile global economy through scenario
analysis and stress testing. It will enable companies to know the kind of potential
economic scenarios - a recession, the disruption of supply chains, and regulatory
changes, to name a few that might affect investments.
b. A business can make much more informed decisions and prepare for adverse
conditions by testing projects against many possible outcomes. This will help
minimise risk and maximise returns when business scenarios are unpredictable.
4. Blockchain and Decentralised Finance (DeFi)
a. First, blockchain and Decentralised Finance (DeFi) are the new entrants that are
beginning to transform capital budgeting. Blockchain provides an immutable ledger
that can ease complex financial transactions and increase the transparency involved
in investment processes. With DeFi, firms can access new, decentralised financial
markets, which can change how a firm seeks capital for its projects.
b. What will be expected is a future of blockchain-based capital budgeting platforms
where the business can track investment decisions securely and verify them,
reducing fraud and increasing transparency. This factor will be increasingly
widespread as blockchain continues to grow.
5. Risk Management and Capital Allocation
a. Capital budgeting processes must take up more sophisticated risk management
strategies to consider the complexity and interdependence of such businesses. In
the upcoming decade, namely 2025, companies should look into not only the
traditional financial risks but also address non-financial risks in the shape of climate
change, cyber threats, and geopolitical instability.
b. This would unlock new capital allocation models, aligning financial performance
with risk mitigation. Companies must prioritise projects that could endure external
shocks and provide long-term resilience, even under uncertainty.
6. The Role of Cloud-Based Financial Tools
a. The other trend which is transforming capital budgeting is migration to cloud-based
financial tools. The better provision of flexibility and collaboration, in combination
with open access to real-time financial data, makes companies opt for these
platforms. Various cloud-based tools allow teams to work together efficiently,
regardless of location, making assessing investments and resource management
easier.
b. Besides facilitating collaboration more effectively, cloud tools can also support more
precise forecasting and analysis, therefore allowing companies to better understand
the long-term value of their investments. That is a trend that will be strengthened in
the coming years as cloud technology becomes even more complex and widespread.
7. Automated Capital Budgeting Systems
a. Of course, automation is not exclusive to AI. Automated capital budgeting systems
have become very popular because they reduce decision-making time. Such systems
can include everything from preliminary project proposals to final approval, thus
saving much time that would normally be needed to evaluate and clear investments.
b. Automating time-consuming tasks creates an opportunity for a business to free up
time to focus more strategically on real management choices. The efficiency of
results increases while, at the same time, the chances of human error decrease.
Automation enables the assessment of more projects within the same day and
capital allocation to the best opportunities.
8. Increasing Importance of Intangible Assets
 a. Capital budgeting was mainly about tangible assets in the past, such as buildings,
machinery, and infrastructure. Today, however, intangible assets greatly valued by
users include intellectual property, brand value, and customer relationships. By
2025 and beyond, business investment decisions will also have to reflect these
intangible assets.
b. The problem is with the value of such an asset, which would require a more
subjective valuation. Firms would have to work on a new framework and
methodology for determining the ROI on intangible assets during capital budgeting
to recognise such an element.
9. Agile Capital Budgeting Frameworks
a. The future of capital budgeting could finally see an increasing trend of adapting to
more flexible frameworks. Over time, capital budgeting has been a very formal
process strictly bounded by timelines and guidelines. However, this is not the case in
today's aggressive business environment, in which companies need to adjust faster
than ever to market conditions.
b. Agile capital budgeting would ensure companies can review and change their
investment strategies more quickly in light of new opportunities or threats. It cuts
across dynamic fields such as technology and health care, where the playing ground
constantly changes.
c. The capital budget in the future is going to be dynamic and transformative. As we
step into 2025, things will be drastically different regarding changes in capital
budgeting. Presented with increasing technological assistance, even more
importance attached to sustainability, and the call for more nimble decision-making,
businesses will stay ahead on these trends or lose out on the game.
1. Behavioral aspects of capital budgeting.
Capital budgeting decisions are not only influenced by economic factors, but also by
psychological and social factors that affect the preferences, beliefs, and biases of
managers and stakeholders. Behavioral capital budgeting research examines how these
factors affect the capital budgeting process and outcomes, and how they can be mitigated
or exploited to improve decision making. For example, some studies have investigated
how overconfidence, optimism, regret, framing, and social norms affect capital budgeting
choices and performance (e.g., Baker et al., 2011; Ben-David et al., 2013; Graham et al.,
2013).
1. Environmental, social, and governance (ESG) issues in capital budgeting.
ESG issues are becoming increasingly important and relevant for firms and investors, as
they reflect the social and environmental impact of business activities and the quality of
corporate governance. ESG issues can affect the risk and return of capital investments,
as well as the reputation and legitimacy of firms. Capital budgeting research can explore
how ESG issues are incorporated into the capital budgeting process, how they affect the
valuation and selection of projects, and how they influence the performance and
sustainability of firms. For example, some studies have examined how ESG factors affect
the cost of capital, the hurdle rate, the project cash flows, and the project ranking (e.g.,
Eccles et al., 2014; Goyal and Serafeim, 2019; Krueger et al., 2020).
2. Digital transformation and innovation in capital budgeting.
Digital transformation and innovation are reshaping the business landscape and creating new
opportunities and challenges for firms. Capital budgeting research can investigate how firms
adapt and respond to the digital transformation and innovation, and how they allocate and
manage their capital resources in this context. For example, some studies have explored how
 digital technologies, such as artificial intelligence, big data, cloud computing, and blockchain,
affect the capital budgeting process and outcomes, and how they enable new forms of capital
investments, such as platform-based, network-based, and ecosystem-based projects (e.g.,
Bharadwaj et al., 2013; Bughin et al., 2017; Hoberg and Phillips, 2019).

3. Real options and flexibility in capital budgeting.

Real options and flexibility are important concepts and tools for capital budgeting, as they
capture the value of being able to adjust and adapt to changing circumstances and uncertainties.
Capital budgeting research can examine how firms use real options and flexibility to enhance the
value and efficiency of their capital investments, and how they cope with the challenges and
limitations of applying real options and flexibility in practice. For example, some studies have
analyzed how real options and flexibility affect the valuation and selection of projects, how they
interact with other factors, such as irreversibility, competition, and learning, and how they can
be implemented and measured (e.g., Dixit and Pindyck, 1994; Trigeorgis, 1996; Smit and
Trigeorgis, 2004).
.

Risk in Capital Budgeting,

Q.2 State the risks in Capital Budgeting ?

1. Pre-Investment Phase 2. Investment Phase
(Identification & Evaluation) (Selection & Approval)

This phase involves project This phase includes final project

identification, feasibility studies, and approval, funding allocation, and
preliminary analysis. resource mobilization.
i. Strategic Misalignment Risk:
a. Projects may not align with i. Approval Bias Risk:
the company’s long-term a. Decisions influenced by
goals or core competencies. managerial overconfidence or
b. Example: Investing in a trendy political motives.
but unrelated industry b. Example: Approving a pet project
without expertise. despite negative NPV.
ii. Market Risk: ii. Financing Risk:
a. Misjudging market demand, a. Inability to secure funds at
competition, or customer favorable terms (e.g., rising
preferences. interest rates).
b. Example: Overestimating b. Example: Delays due to failed
demand for a new product debt/equity issuance.
due to poor market research. iii. Resource Allocation Risk:
iii. Data & Assumption Risk: a. Overcommitting funds or
 a. Errors in forecasting cash diverting resources from core
flows, costs, or growth rates. operations.
b. Example: Underestimating b. Example: Cannibalizing working
raw material costs due to capital for a new project.
inflationary trends. iv. Hurdle Rate Risk:
iv. Regulatory Risk: a. Using an inappropriate discount
a. Changes in laws, taxes, or rate (too high or low).
environmental policies during b. Example: Overlooking risk-
the planning stage. adjusted returns by using a
b. Example: A new carbon tax generic WACC.
increasing project costs v. Mitigation:
unexpectedly. a. Use capital rationing to
v. Opportunity Cost Risk: prioritize projects.
a. Choosing one project over a b. Validate the discount rate
potentially better alternative. using risk-adjusted hurdle
b. Example: Allocating funds to a rates.
low-return project while c. Ensure transparent approval
ignoring a high-growth processes with checks and
opportunity. balances.
vi. Mitigation:
a. Conduct sensitivity
analysis and scenario
planning.
b. Use SWOT analysis to align
projects with strategy.
c. Validate assumptions with
historical data and expert
opinions.

3. Execution Phase 4. Post-Investment Phase

(Implementation) (Monitoring & Review)

This phase covers project execution, This phase involves tracking

construction, and operational setup. performance, comparing actual vs.
Risks: projected outcomes, and making
i. Cost Overrun Risk: adjustments.
a. Exceeding the budget due to delays, Risks:
inflation, or inefficiencies. i. Performance Deviation Risk:
 b. Example: Construction delays a. Actual cash flows falling short of
increasing labor costs by 30%. projections.
ii. Technical Risk: b. Example: Lower sales due to
a. Failure of technology, design flaws, or unanticipated competition.
integration issues. ii. Obsolescence Risk:
b. Example: A manufacturing plant’s a. Technological advancements making
machinery underperforming. the project outdated.
iii. Operational Risk: b. Example: A new energy-efficient
a. Inadequate workforce, supply chain technology rendering existing
disruptions, or process inefficiencies. machinery obsolete.
b. Example: Strikes halting production iii. Economic/External Shock Risk:
mid-implementation. a. Recessions, geopolitical crises, or
iv. Timeline Risk: natural disasters.
a. Delays in completion affecting revenue b. Example: A pandemic reducing
generation. demand for a newly built hotel.
b. Example: Regulatory approvals taking iv. Exit Risk:
longer than planned. a. Difficulty in abandoning or divesting a
v. Mitigation: failing project.
a. Adopt project management b. Example: High sunk costs preventing
tools (e.g., Agile, CPM). termination of a loss-making venture.
b. Include contingency budgets and v. Mitigation:
buffers for timelines. a. Conduct post-audits to identify
c. Use pilot testing for variances.
technology/processes. b. Implement real options (e.g.,
flexibility to expand/abandon).
c. Monitor external factors (e.g.,
economic indicators, competitor
moves).

Internal and External Factors impacting capital budgeting decisions

Q.3. State the Factors influence decision making of capital budgeting decision.
Answer The factors effecting decision-making are Internal factors and External factors:-

Internal factors External factors

i. Financial Resources: Availability of i. Economic Conditions: GDP growth,
cash, retained earnings, or internal recession risks, or market demand
funding. trends.
 ii. Strategic Alignment: Consistency ii. Interest Rates: Cost of borrowing
with long-term goals and business and availability of credit.
strategy. iii. Inflation: Impact on input costs and
iii. Management Expertise: Skills and future cash flows.
experience of leadership to execute iv. Government Regulations:
projects. Compliance requirements, tax
iv. Risk Tolerance: Willingness to policies, or environmental laws.
accept uncertainty (e.g., v. Competitive Landscape: Rival
conservative vs. aggressive investments, pricing pressures, or
approaches). market share threats.
v. Cost of Capital: Required rate of vi. Technological Changes: Disruptions
return (hurdle rate) for project or advancements affecting project
approval. viability.
vi. Debt Levels: Existing leverage and vii. Consumer Demand: Shifts in
capacity to take on additional debt. preferences or purchasing behavior.
vii. Operational Efficiency: Current viii. Financing Availability: Access to
capacity to integrate and manage external equity/debt markets.
new projects. ix. Political Stability: Risks from
viii. Company Policies: Approval geopolitical tensions, trade policies,
processes, sustainability criteria, or or sanctions.
ethical guidelines. x. Global Factors: Exchange rate
ix. Human Resources: Availability of fluctuations, international trade
skilled employees to support the agreements, or tariffs.
project. xi. Supply Chain Dynamics: Reliability
x. Past Performance: Track record of of suppliers, raw material costs, or
previous investments logistics.
(successes/failures). xii. Labor Market Conditions:
xi. Corporate Culture: Innovation Availability of skilled workforce and
focus, risk appetite, or decision- wage trends.
making style.
xii. Organizational Structure:
Centralized vs. decentralized
authority in project approvals.
Methods of evaluating financial risk in capital budgeting techniques.

Q. 4 What are the techniques of Evaluating financial Risk of capital budgeting ?

Ans 4 Capital Budgeting Techniques:

1. Net Present Value (NPV)

NPV sums the present value of a project's cash inflows and subtracts the present value of
cash outflows. If NPV is positive, the project is fruitful. If NPV is a negative one, the
project should be rejected.
Advantages
The benefits of the NPV method as one of the various techniques capital budgeting have
been stated below.
o Assumption of cash flows over the life of the project
o Accounts for the time value of money
o Easy to calculate and interpret
Disadvantages
The flaws of the NPV method as one of the various techniques of capital budgeting have
been stated below.
o Needs exact forecasts of future cash flows
Example
A project costs $100,000 initially and is hoped to yield $50,000 at the end of years 1, 2,
and 3. With a 10% discount rate:
Year 0: -$100,000
Year 1: $50,000 / (1.1)^1 = $45,454
Year 2: $50,000 /(1.1)^2=$41,316
Year 3: $50,000 /(1.1)^3 = $37,416
NPV = $24,186. The project is useful.
2. Internal Rate of Return (IRR)
IRR is the discount rate that equals zero NPV of a task's cash flows. If the IRR is higher
than the cost of capital, the project is useful.
Advantages
The benefits of the IRR method as one of the various techniques of capital budgeting
have been stated below.
Easy to figure out and solve
o Useful for ranking project
Disadvantages
The flaws of the IRR method as one of the various techniques of capital budgeting have
been stated below.
o The size and timing of cash flows is not considered
o May show multiple IRRs for uneven cash flows
Example
The IRR is calculated to be 18% using the same cash flows. Since this exceeds the 10%
discount rate, the project is worthwhile.
The article continues to discuss the payback period, profitability index, discounted cash
flow methods, sensitivity analysis, simulation techniques, and real options analysis -
 highlighting the pros/cons of each technique with examples. A blend of techniques is
advised to assess capital budgeting projects from multiple views.
.
3. Payback Period
Measures the years for cumulative cash inflows to equal initial cash outflow. Projects
with shorter payback periods are preferred over the rest.
Advantages
The benefits of the payback period method as one of the various techniques of capital
budgeting have been stated below.
o Simple and intuitive
o Incorporates time dimension
Disadvantages
The flaws of the payback period method as one of the various capital budgeting
techniques have been stated below.
o Ignores cash flows after the payback period achieved
o Time value of money is not taken into account.
o May accept risky projects with front-loaded cash flows
4. Profitability Index
The ratio of the present value of cash inflows to initial investment. Projects with PI > 1
are desirable.
Advantages
The benefits of the profitability method as one of the various techniques of capital
budgeting have been mentioned below.
o Considers size of cash flows and investment
Disadvantages
The flaws of the profitability index method as one of the various techniques of capital
budgeting have been stated below.
o Skips the timing of cash flows
o May favor smaller projects with shorter lives
Read about Capital market.
5. Accounting Rate of Return
The ratio of average annual accounting income to average investment.
Advantages
The benefits of the accounting rate of return method as one of the various techniques of
capital budgeting have been stated below.
o Easy to estimate and understand
Disadvantages
The flaws of the accounting rate of return method as one of the various techniques of
capital budgeting have been stated below.
o Skips the time value of money
o May accept high-risk projects
6. Sensitivity Analysis
It affects varying beliefs to test how variations in key factors impact project viability.
Advantages
The benefits of the sensitivity analysis method as one of the various techniques of capital
budgeting have been stated below.
 o Assesses risk and delay
o Recalls critical drivers of project success
Disadvantages
The flaws of the sensitivity analysis method as one of the various techniques of capital
budgeting have been stated below.
o Needs to define reasonable ranges for input variables.
Read about financial services.
7. Simulation Techniques
Use Monte Carlo or other statistical methods to determine probability distributions of
results.
Advantages
The uses of simulation techniques as one of the various techniques of capital budgeting
have been stated below.
o Capture delay better than deterministic methods.
Disadvantages
The flaws of simulation techniques as one of the various techniques of capital budgeting
have been stated below.
o Needs complex modeling and beliefs
o Results can be driven by arbitrary simulation parameters
8. Real Options Analysis
Think about how a project's flexibility creates optionality, and optionality has value.
Advantages
The benefits of the real options analysis method as one of the various techniques of
capital budgeting have been stated below.
o Seizes strategic flexibility and ability to respond to fate
o Splits upside prospect from downside risk
Disadvantages
The drawbacks of the real options analysis method as one of the various techniques of
capital budgeting have been mentioned below.
o Needs complex modeling and beliefs
o Hard to quantify some option values
Also, read about Financial Institutions.
9. Multiple Criteria Approach
Consider results from multiple techniques like NPV, IRR, payback period, and
profitability index.
Advantages
The benefits of the multiple criteria approach method as one of the various techniques of
capital budgeting has been noted below.
o Feeds a more wide evaluation of projects
o Lowers the risk of decision errors from a single step
Disadvantages
The disadvantages of the multiple criteria process method as one of the various
techniques of capital budgeting have been noted below.
o Requires judgment to decide which results carry more weight
10. Discounted Cash Flow Methods
 Beyond NPV and IRR, methods like Modified Internal Rate of Return and Net Annual
Worth are used. These consider the cash flows over the life of the project and discount
future cash flows.
Read about the foreign exchange management act fema.
11. Benefit/Cost Ratio
The ratio of the present value of benefits to the present value of costs. Projects with
ratios > 1 are desirable.
Advantages
The benefits of the benefit/cost ratio method as one of the various techniques of capital
budgeting have been noted below.
o Feeds an intuitive ratio of project benefits close to costs
Disadvantages
The flaws of the benefit/cost ratio method as one of the various techniques of capital
budgeting have been noted below.
o Difficult to reliably quantify all benefits and costs
12. Sunk Costs and Incremental Analysis
Sunk costs already incurred should be missed. Projects should be assessed based on
relevant gradual cash flows and costs. This process eases suboptimal decisions caused by
sunk cost bias.
Examples of sunk costs in capital budgeting findings include the next.
o Research and growth costs incurred before a product is launched
o Costs related to developing a capital budgeting bid
o Prior investments in tools that will be changed

5. Modified Internal Rate of Return (MIRR)

Q. 5 What is the Modified Internal Rate of Return (MIRR)?

The modified internal rate of return (commonly denoted as MIRR) is a financial measure
that helps to determine the attractiveness of an investment and that can be used to
compare different investments. Essentially, the modified internal rate of return is a
modification of the internal rate of return (IRR) formula, which resolves some issues
associated with that financial measure.

MIRR or Modified Internal Rate of Return refers to the financial metric used to assess precisely
the value and profitability of a potential investment or project. It enables companies and
investors to pick the best project or investment based on expected returns. It is nothing but the
modified form of the Internal Rate of Return (IRR).

MIRR vs. IRR

The modified internal rate of return (MIRR) and the internal rate of return (IRR) are two closely-
related concepts. The MIRR was introduced to address a few problems associated with the IRR.
For example, one of the main problems with the IRR is the assumption that the obtained
positive cash flows are reinvested at the same rate at which they were generated. Alternatively,
the MIRR considers that the proceeds from the positive cash flows of a project will be reinvested
at the external rate of return. Frequently, the external rate of return is set equal to the company’s
cost of capital.

Also, in some cases, the calculations of IRR may provide two solutions. This fact creates
ambiguity and unnecessary confusion regarding the correct outcome. Unlike the IRR, the MIRR
calculations always return a single solution.

The common view is that the MIRR provides a more realistic picture of the return on the
investment project relative to the standard IRR. The MIRR is commonly lower than the IRR.

MIRR is a financial measure used by firms and investors to calculate the cost and profitability of a new
investment or project. It is simply a tweaked form of the Internal Rate of Return (IRR).
It rates investments and projects based on the opportunities they provide and eliminates capital budgeting
errors caused by IRR.
Unlike IRR, which misleads investors into expecting bigger returns, MIRR provides a precise assessment
of the ROI investors can expect.
It ranks investments based on their opportunities and eradicates all issues arising due to multiple IRRs for
the same period.
How To Calculate MIRR

Discounted Approach – All negative cash flows are discounted to the current investment and added to
the initial cost.
Reinvestment Approach – All positive and negative cash flows (except the first one) are compounded to
the end of the project tenure, and IRR is calculated on the same.
Combination Approach – It is the hybrid method where the above two are merged and applied. In this
approach, all negative cash flows are discounted back to the current investment, and all positive cash
flows are compounded for the IRR to be calculated.
MIRR Formula
The MIRR formula used by firms and investors in capital budgeting is as follows:

Where,
FVCF = Future cost of the positive cash flows after deducting the reinvestment rate or cost of capital:
FV = ∑
Here, Ci is the positive cash flow, and RR is the reinvestment rate
PVCF = The present cost of the negative cash flows after deducting the finance cost of the firm:
PV = C₀ - ∑
Here, C0 is the negative cash flow, and FR is the finance rate
n is the number of years
Calculating Modified Internal Rate of Return manually using the formula could be difficult and result in
errors. Therefore, financial firms and stock dealing companies use spreadsheet applications like Microsoft
Excel to assess the return on investments. The MIRR Excel function is:
= MIRR (value_range, finance_rate, reinvestment_rate)
Where,
Value range = The range of cells containing cash flow values from each period
Finance rate = The cost of capital of the firm or interest expense during negative cash flows
Reinvestment rate = Compounding rate of return on the reinvested positive cash flow
Examples
Let us consider the following MIRR example with calculations to understand the concept better:
Example #1
A company made an initial investment of $1,000 for a project, expecting returns in cash worth $300, $600,
and $900 for three consecutive years. The cost of capital and the reinvestment rate was 12%. Hence -
FV = 300 * (1+0.12)2 + 600 * (1+0.12)1 + 900
= (300 * 1.25) + (600* 1.12) + 900
= 375 + 672 + 900
= 1947
PV = 1000
Using Modified Internal Rate of Return formula:

= 24.87%
Example #2
A company invests $1,800 and evaluates the return worth $500 to be consistent for the next three years
with an additional profit of $500 at the end of the third year. What is the difference between the IRR
and Modified Internal Rate of Return of the project if the reinvestment rate is 10% and IRR is 12%?
FV = 500 * (1+0.10)2 + 500 * (1+0.10)1 + 1000
 = 605 + 550 + 1000
= 2155
PV = 1800

= 6.18%
The difference between the IRR and Modified Internal Rate of Return is equal to = (12 – 6.18) %
= 5.82%
IRR vs MIRR - Which Is Better?
Both IRR and Modified Internal Rate of Return are interrelated terms when considering a new investment
or project. However, a few things make one option better than the other. Let us look at them:

IRR MIRR

Overstates the returns expected on an

Provides an exact estimation of the returns
investment

Resolves issues that arise in capital budgeting

Can result in capital budgeting errors
because of multiple IRRs

Calculates reinvestment rate, accounts, and Calculate returns based on the assumed respective
cash flows stage-wise current reinvestment rates that apply

Assumes reinvestment of cash flows at the Assumes reinvestment of positive cash flows at the
same rate, i.e., IRR cost of capital

Discounts the growth from the initial Consider financing the initial expenses at the finance
investment cost

Works like the inverted compounding of the Helps managers expect a realistic return and plan
growth rate their objectives accordingly

Sometimes provides two solutions that

Always offers a single solution
cause ambiguity or misunderstanding

Assumes the growth rate to remain constant Assumes the rate of reinvested growth to vary at
from project to project different stages in a project

Uses Of MIRR
The regular IRR exaggerates the returns on investment, giving investors false hope. On the other hand,
MIRR assesses different costs to conclude the returns one can expect from an investment. Thus, it
prevents investors and firms/business managers from being misled. Besides this, there are multiple other
financial aspects with which Modified Internal Rate of Return can help:

 Ranks investments of similar size based on the opportunities they provide

  MIRR higher than the expected return suggests an attractive investment or project and vice versa
 Modifies IRR of an investment or project and calculates the difference between the reinvestment
rate and the investment return
 Eradicates all issues arising due to multiple IRRs for the same period
 Keeps room for adjustment of the assumed growth rate of the reinvestments at different stages of
project accomplishment
 Offers the liberty to add any reinvestment rate and make the calculations based on that

UNIT II

Risk Analysis in Capital Budgeting Decisions

Q. 6 State and explain different Risk Analysis in Capital Budgeting Decisions?

Answere

 Statistical Techniques: Probability, Standard Deviation and Co-efficient of Variation

 Conventional Techniques
 Other Techniques

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