Archive for August, 2006

How to calculate an internal rate of return (IRR), and when not to use it

Corporate finance

Calculating the of a project is one of the most popular methods that companies and managers use to determine whether a project is worth investing in. Now that I’ve covered a bit about NPVs and , it makes sense to go through what IRR is, how to use it, and why it’s not an ideal measurement.

When using NPV to determine whether or not to invest in a project, the general rule is to accept the project if NPV > 0 and reject if NPV is negative (or zero).

But since NPV results in a dollar figure, some managers have a hard time conceptualizing what that number (the present value of future cash flows) really represents. Instead, they prefer to look at percentages, and that’s where IRR comes in.

IRR is the rate at which the project NPV equals 0. It also provides the expected return rate of the project, assuming certain conditions are met. In other words, if C(n) is the cash flow for each period, then

NPV = C(0) + C(1)/(1+r) + C(2)/(1+r)2 + … + C(n)/(1+r)n

and you’d find IRR by setting NPV = 0 and solving for “r” above. (Excel’s IRR function makes this all a cinch by running an iterations.)

Let’s look back at Experiment in Finance’s NPV calculation as an example.

I noted in my previous entry that this site’s NPV through July was $89.93. Here are the cash flows again:

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Government bureaucracy gives me a headache!! Learn from my mistakes.

Personal finance

I should have known that the luck of successfully submitting and receiving approval on my husband’s green card application in good time wouldn’t last. We received his I-551 (green card) in the mail yesterday, only to discover that his birthdate had been misentered by the USCIS. Instead of showing the his birthdate as “10”, it showed “01”. To get this fixed, we now have to file a I-90 form, wait for it to be accepted, then set up an appointment to appear in the local USCIS office with the old card, proof of his real birthdate, and proof that it was a mistake on USCIS’s part.

This last part is what’s so annoying. In an attempt to become a little more efficient, the USCIS has allowed fillable PDF files for some time now, so on the original application, we’d simply typed in the information on the PDF file, printed it out, and then signed it before submitting the application for processing. I, stupidly, didn’t make a photocopy of the application, and of course, the one time I decide not to cover my bases with the government, they make a mistake.

I have the PDF file, saved and untouched since we filled it out, sitting on the computer, showing we’d correctly entered my husband’s birthdate. But without a photocopy of the original, signed and submitted form, I can’t prove that it was an administrative error on the USCIS’s part, so we’ll have to pay a whopping $260 processing fee on top just to get the birthdate error corrected! No proof of their mistake = no waiver of fee.

Not to mention the time we’ll lose re-filing, re-appearing in person, waiting again for a new card, and paying for a trackable, guaranteed delivery method. Even more annoying when compared to the fact that I could have spent 10 minutes driving to Staples for a $0.10 copy of the signed form before we’d filed it initially. Ugh! Oh well. We’ll still try to submit a hard copy of the PDF application anyway and see if they’ll accept that as “proof” but I’m not keeping my hopes up.

The moral of this story is, when you do anything related to the government, be sure to photocopy everything, even though it’s annoying and chances are it’ll be a complete waste of money, trees, and time. The minute you don’t, you’ll end up paying even more.

Ahh, taxes…

Personal finance

Be sure to check out the Tax Carnival over at Don’t Mess with Taxes. Kay was kind enough to include the comments on an article I wrote for All Things Financial regarding changes in Roth IRA tax laws.

There are some great resources included in the Carnival, including one on tax resources on the Internet.

Okay, so taxes are not what everyone would choose to spend their free time reading about. But if you’re like me, you sometimes end up ignoring this very real and significant impact to your finances until it’s too late. (For example, after writing my recent post on employee stock purchase plans, I realized I completely neglected to mention that there are definite tax implications depending on whether you have a or !)

So head on over and educate, or at least bookmark some of these posts. (There’s even a lighter one on what celebrity you’d tax to bring the budget back into balance). After all, how often can you get free CPA advice? And come next April, if not sooner, you’ll be glad you did!

How to calculate net present value (NPV) – an introduction

Corporate finance

I’ve been meaning to write a bit about NPV after having discussed and using NPV to calculate the valuation of this site. Since I haven’t written about corpoate finance in a while, I thought this might be a good change of pace.

When we calculate DCFs, what we’re essentially trying to do is calculate the value of all the future cash flows at a given point in time, most often at the present moment. As discussed earlier, to do this, you need to know or forecast future cash flows in each period as well as have a in mind that reflects the riskiness of the project or events leading to the cash flows.

One way to determine whether a project is worth accepting or not is to look at its net present value (NPV). At a high level, NPVs are very much like DCFs. NPVs involve comparing the present value of cash inflows with cash outflows, and calculating each one can get complicated depending on how a company is set up (leveraged or unleveraged) because deciding what to include or exclude and their interactions with tax can get hairy. So, to simplify this discussion on IRR, I’ll use Experiments in Finance’s NPV calculations to demonstrate.

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Anyone ever tried this frugal (or strange) tip?

Tips for saving money

From reddit: . Seems like a nice, cheap way to get a mid-afternoon snack for the office.

On the other hand, I’d want it done in a pretty clean car (I like my cookies smelling like cookies and not picking up odors of stale and hidden fast food). I’m also not sure I’d want to do it and leave my car smelling like cookies. Mightn’t that attract ants and such?