Download Seminar in Financial Management

Seminar in Financial Management
Kiky Natalia
IBMP-16568
Article From CRP

Title
Capital Budgeting : NPV v. IRR Controversy
Unmasking Common Assertions
By Jan F.Jacob

Topic
Conflict between NPV and IRR
Theory used by article/ research
 “Capital
budgeting decisions are among
the most important choices made by
managers; selection or rejection of
investment proposals defines the firm’s
profitability and, in the end, its survival.”
Keef and Roush (2001)
Theory used by article/ research
 “The
common assertion that the NPV v.
IRR controversy hinges on the rate of
reinvestment… is… based on a
misunderstanding.. Conflict between IRR
and NPV can be attributed entirely to the
effects of scale.”(Keane,1979,55)
Theory used by article/ research
“
mathematics is a tool… economics [is]
the master …[the] problem arises from
confusion of this hierarchy-from trying to
make economics conform to the
mathematics (Herbst, 1982,92)

Hypothesis of research

The NPV-method and the IRR-method aren’t
two measures of investment worth, but just
one single method.

The NPV/IRR-method is a plain mathematics
and does not pretend to be ranking device; it
cannot be used as such either.
Variables used in research
 C=
money units
 Discount rate ‘per’ period (discrete),
for each of three period
 NPV
Method of analysis
 Present
value method or (a variant) the
method of the internal rate of return.
Result of the analysis/ research
(Conclusion)
 The
present value method fails in
numerous cases in making sound
capital budgeting decisions. This is
because the fact that the NPV/IRRmethod meets only nominal’s.
Article from Student
Title
Capital Budgeting with Taxes under Uncertainty and
Irreversibility
By Rainer Niemann, Tubingrn, and Caren Sureth, Paderborn



Topic
The derivation of post-tax investment rules and neutral
tax systems under risk neutrality and risk aversion for
irreversible investment projects.
Theory used by article/ research
Under condition of uncertainty and irreversibility, real
option-based models
1. Are wideliy accepted for assessing investment project.

Dixit/ Pindyck (1994), Trigeoris ( 1996)
In recent years, public economics have extended real
option literature by integrating taxation.Morreto (2000)
3. By doing so, its possible to derive investment rules
considering managerial flexibility, irreversibility, tax
effect, and to identify tax systems that are neutral with
respect to investment decision.
Harchauwill/ lassere (1996), Jow (200), Pennings ( 2000)
Agliardi (2001)
2.
Theory used by article/ research




Deterministic examples for neutral tax systems are the
cash flow tax and the taxation of true economics profits.
Brown (1948)
In recent years, public economist was especially
interested in tax neutrality under uncertainty.
Samuelson (1964), and Johansson (1969)
Theory used by article/ research
For risk neutral investors, neutral tax systems
have been already been proved in the real
option context, whereas neutral tax systems
under risk aversion and irreversibility have not
yet been derived.
Niemann (1999), Sureth (1999), Sureth (2002)
 Integrating taxes reveals interesting differences,
especially under risk aversion.
Knudsen/Meister/Zervous (1999)

Hypothesis of research
 Exercising
option to invest is assumed
completely irreversible, which implies that
it is impossible to abandon a project
during its economic life ending at time T. T
maybe finite or infinite.
Variables used in research
Single profits tax
 Operating cash flow π
 Depreciation allowances d
 Interest taxation parameter

Method of analysis
 General
assumptions
Derive the optimal investment rule under
uncertainty and to assess the value of the
option Dynamic Programming
Result of the analysis/ research
(Conclusion)

The main reason for employing real option approach
instead of traditional models of capital budgeting under
uncertainty are the introduction of managerial flexibility
in light of irreversibility and the possibility to abstract
from individual risk preferences.

Since neutrality conditions are always transformations of
the underlying model assumptions, the differentiation
between dynamic programming and contingent claims
analysis is crucial with tax neutrality