Chapter 3 extract from our ExPress notes for

use with the current video.

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Notes
CIMA Paper P1
Performance Operations
For exams in 2011

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ExPress Notes
CIMA P1 Performance Operations

Investment:

(200)

FV:
PV:

(200)

100

100

125

105

140

90.9

82.6

93.9

71.7

86.9

In the table above, the (simple) payback period is in Year 2;

The Discounted Payback period is longer (Year 3).

Relevant Cash Flows

When evaluating projects, cash flow projections must meet the criteria of relevance.
Relevance refers to cash flows that are relevant to the decision whether to accept a project
or not. Cash flows that are created (or discontinued) as a result of taking the decision (to
undertake the project) are relevant; these are also called incremental cash flows.
Included in relevant cash flows would be any investments in equipment and working capital
required by the project. More subtle, but no less important, are any opportunity costs
incurred as a result of accepting the project.
Cash flows which occur whether the project goes ahead or not are not relevant. Also not
relevant are:
Sunk costs;
Committed costs;
Allocated (overhead) costs;
Non-cash expenses
Depreciation is an example of a non-cash expense. One may need to work with
depreciation, however, if they are related to a calculation of taxes due. Any change in the
amount of taxes paid is a very relevant cash flow!

KEY KNOWLEDGE
Internal rate of Return
The internal rate of return (IRR) is defined as the discount rate (r) at which the net present
value (NPV) of a stream of cash flows will be equal to zero. In other words,
If, at a discount rate r, NPV = 0, then IRR = r
The IRR includes among its assumptions the following: any cash flows generated in the
course of a project being evaluated are calculated as being reinvested at the IRR rate. This
is illustrated thus:

Page | 2

2011 The ExP Group. Individuals may reproduce this material if it is for their own private study use only. Reproduction by any means for any
other purpose is prohibited. These course materials are for educational purposes only and so are necessarily simplified and summarised. Always
obtain expert advice on any specific issue. Refer to our full terms and conditions of use. No liability for damage arising from use of these notes
will be accepted by the ExP Group. .

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ExPress Notes
CIMA P1 Performance Operations

Time

Cash flows

0
1
2

(20,000)
5,000
30,000

The IRR of the above cash flows (using interpolation or calculator) is 35.61%.

Comparison of NPV and IRR methods

The following decision rules apply to appraisal methods:
NPV: Positive NPV projects are acceptable; the higher the better.
IRR: An IRR in excess of a hurdle rate (set by the company) indicates acceptability; the
higher (the IRR) the better.

NPV vs. IRR -- EXAMPLE

Year

IRR

-5,000

6,000

-7,500

8,850

NPV:

10%

14%

16%

20%

454

263

172

18%

545

263

129

Intuitively, IRR should be preferable, as it relates return to amount invested.

Equal investment amounts do not necessarily remove the ambiguity.

EXAMPLE
Year

Page | 3

IRR

NPV (9%)

-500

100

600

20%

97

-500

500

155

25%

89

2011 The ExP Group. Individuals may reproduce this material if it is for their own private study use only. Reproduction by any means for any
other purpose is prohibited. These course materials are for educational purposes only and so are necessarily simplified and summarised. Always
obtain expert advice on any specific issue. Refer to our full terms and conditions of use. No liability for damage arising from use of these notes
will be accepted by the ExP Group. .

theexpgroup.com