IRR and NPV
#tvm
Another perspective on value creation comes from converting the initial investment into a capital charge against the annual operating cash flows that the project generates. Recall that the project generates an annual operating cash flow of ¥294,800,000. If we subtract a capital charge of ¥270,570,310 (the amount of a five-year annuity having a present value of ¥1,000 million at 11 percent), we find ¥294,800,000 − ¥270,570,310 = ¥24,229,690. The amount of ¥24,229,690 represents the profit in each of the next five years after taking into account opportunity costs. The present value of a five-year annuity of ¥24,229,690 at an 11 percent cost of capital is exactly what we calculated as the project’s NPV: ¥89.55 million. Therefore, we can also calculate NPV by converting the initial investment to an annual capital charge against cash flow.
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