IRR Discussion Blowhards who Complain about IRR Recent
IRR Discussion
Blowhards who Complain about IRR • Recent E-mails • Do these finance professors really believe that they know so much better than people in the real world who invest real money. • History of IRR and a nice comparable number that does not depend on WACC 2
E-mail from Amsterdam Institute of Finance • Arrogant Business School Professors in Amsterdam 3
Harvard and IRR • Hi Ed, • Enclosed is the 3 HBR articles, good ones to read. IRR, Payback, etc, all tools that we learn from current corporate textbooks, are assuming financial capital scarcity, which might not be relevant now for digital-based companies. • Karnen
Mc. Kinsey and IRR • Proved with and extreme example that IRR can produce different results from NPV 5
IRR Comments/Questions • Marie: • You can get whatever IRR you want when you assume re-financing, asset sales, different financing … It is just a number in the financial model that does not mean much • Samihah (Lawyer) • What is all this business about the IRR anyway (please don’t say it is the discount rate that makes the NPV equal zero)
Summarising Performance of a Project • In introducing a modelling course, I discuss how you measure performance for debt and equity investors. No statistic is perfect, but I suggest the IRR and the DSCR remain the fundamental items to evaluate 7
Fundamental Question: IRR or WACC • IRR versus Alternatives • IRR and ROIC can be Equated and there is no direct need for WACC or Cost of Capital (i. e. What A Crock of Crap does not affect the statistics). • MIRR, NPV to Investment, Return on Investment with zero re-investment rate all directly depend on WACC or cost of Equity. • These people can’t seem to understand that you can build simple excel models to prove alternative concepts. • Resolution with economic depreciation and weighted average return on investment to resolve IRR problems. 8
Thanks to Finance. Yahoo for Adjusted Stock Price • IRR on a stock with re-investment of dividends is the ultimate way to measure performance. It is the growth rate in your money. It is all you care about if you are obsessed with consuming expensive things. 9
Equity Risk Premium and WACC is the Real Bullshit • You can start with the idea the you need a risk premium, or you would invest in a risk-free security (absolutely not long-term bonds that have inflation risk). • You can say that you can invest in a really big portfolio that grows at the same rate as all businesses in the economy. Unless the aggregate of company profits grows more than the economy, making very large dispersions in income, the return on stocks should be the same as overall economic growth and the equity risk premium is minimal. • You could extend this to risks that employees take and say the employees need a risk premium for working and should take more out of the economy. 10
Thanks Yahoo together so you can Compute IRR • When you make and investment of 1. 0 and it grows to 16, you do not ask about WACC or re-investment rates. 11
Thanks to FRED and Yahoo together to Study These Issues • Note the difference in IRR and the growth rate in the economy in recent years. This a big cause if income distribution discussion. 12
Combining FRED and Yahoo, You Can Adjust For Currencies and Inflation • When you adjust for inflation, the IRR’s are lower. 13
Equity Market Risk Premium is Indeed B. S.
Damodaran DCF Premium 15
EMRP Fernandez 16
Final Damodaran EMRP Recommendation of 5. 96%
Cost of Capital in Same Transaction Top is buy-side (if negotiating would want high cost of capital). Bottom is sell-side.
Effect of WACC on DCF • Variation in value from the cost of capital with the two cases. This is so much more variation than is reported on a Football field diagram.
WACC Craziness – Website with WACC for Insurance http: //www. waccexpert. com/
Problems with WACC and DCF – Range in Values • Note the range in values in the analyst report • The range is less when a terminal value multiple is used, but the range is still very high • The high range exists even though there is a tight range in discount rates
Another Example of High Variation in Valuation from DCF Problems
All or the Normal Alternatives to IRR Require WACC • MIRR • Re-invest at WACC • NPV • Measure at WACC • Weighted Average ROIC • Weighting of Net Investment depends on WACC • Economic Depreciation • Valuation depends on WACC in Value Progression 23
People Do Not Use NPV • Maybe professors want the old NPV rule. • Managers are busy, and how are they supposed to interpret an investment of € 10, 000 versus and investment of € 340, 000. • Now they also have to assess the WACC for the different investments. • One thing we should all agree on is that the WACC must not be the same for different investments • If you are realistic about investments, the risk profile and the capital structure changes over time and this should be in the WACC for computing NPV. 24
You Could Compute NPV/Investment • The NPV divided by the invested capital is analogous to the price to book ratio. • If you really knew the WACC, this is ok and could be compared to price to book or EV/Invested Capital • Of course, this is highly dependent on the WACC assumption. • At the end of the day, there the information is no different than the IRR 25
NPV to Investment • When the NPV/Investment crosses 1. 0, the WACC = IRR. There is not much more information than the IRR in this graph. 26
MIRR is Indeed Bullshit. If You Want a Good Return, Put in A High WACC • There are enough speculative assumptions in a model • Now, managers must see put in an assumption about what kind of investments they will make in 15 years (talk about fortune telling). 27
MIRR and WACC Table and Graph • Note how you are just measuring WACC with the MIRR 28
One Day, the ROIC must be Earned • I hope Dr. Oxford would not disagree that the ROI or ROIC is a reasonable way to gauge performance of just about anything. The notion that you try to find investments with a high return and then grow them must be fundamental. • The problem with computing ROIC for a project finance or LBO or anything where capital expenditures are not continual is that the return increases as straight line depreciation reduces investment. 29
For Bad or Good, Growth is All that Matters, ask Jeff Bezos 30
Should Jeff Bezos’ Payment to his soon to be ex-wife be adjusted because the WACC for Amazon was high • The measurement of Amazon performance can be made with the IRR and not other statistics.
Weighted Average versus MIRR and IRR • Case 1: Not too high IRR. Here the MIRR does not make sense – as the WACC is higher, the economics f the project should be worse 32
Weighted Average versus MIRR and IRR • Case 2: Higher IRR with growth. When the WACC is less than the IRR, the WAROIC is higher and not lower than the IRR 33
Real Critiques of IRR • Changing Risk • Compute IRR with alternative holding periods • Undervaluation of Long-term Cash Flows when the IRR is high 34
Case Study of IRR in the Context of U. S. Tax Equity in Renewable Energy
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