HP 17BII Tutorial, Part III

In the previous section we looked at the basic time value of money keys and how to use them to calculate present and future value of annuities. In this section we will take a look at how to use the HP 17BII to calculate the present and future values of uneven cash flow streams. We will also see how to calculate net present value (NPV), internal rate of return (IRR), and the modified internal rate of return (MIRR).

Example 3 — Present Value of Uneven Cash Flows

In addition to the previously mentioned financial keys, the 17BII also has a menu to handle a series of uneven cash flows. Press the EXIT key to get back to the FIN menu, and then choose the CFLO (cash flow) menu.

Suppose that you are offered an investment which will pay the following cash flows at the end of each of the next five years:

Period	Cash Flow
0	0
1	100
2	200
3	300
4	400
5	500

How much would you be willing to pay for this investment if your required rate of return is 12% per year?

We could solve this problem by finding the present value of each of these cash flows individually and then summing the results. However, that is the hard way. Instead, we’ll use the cash flow menu. All we need to do is enter the cash flows exactly as shown in the table. Again, we must clear the cash flow registers first. In this case we need to press SHIFT INPUT, and then choose YES when prompted. The calculator will prompt you for the cash flows for each period, and the frequency of those cash flows. For now, make sure each #TIMES prompt is set to 1 as you enter your cash flows. All you need to do is to enter the cash flows from the above list when prompted. Use the INPUT key to enter the numbers.

Once all of the cash flows are entered, press EXIT to get to another menu. Choose CALC (calculate). On the CALC menu, we first need to enter 12 into I%. Finally, press NPV to find that the present value is \$1,000.17922. Note that you can easily change the interest rate by simply re-entering it and then solving again for the NPV.

Example 3.1 — Future Value of Uneven Cash Flows

Now suppose that we wanted to find the future value of these cash flows instead of the present value. On most calculators, there is no key to do this. On the 17BII, however, all we need to do is to press NFV (net future value) in the CALC menu to see that the future value is \$1,762.65754. Pretty easy, huh?  Now press EXIT to return to the CFLO menu for the next example.

Example 4 — Net Present Value (NPV)

Calculating the net present value (NPV) and/or internal rate of return (IRR) is virtually identical to finding the present value of an uneven cash flow stream as we did in Example 3, except that we also need to supply the initial outlay (cost) of the investment.

Suppose that you were offered the investment in Example 3 at a cost of $800. What is the NPV?  IRR?

To solve this problem, we must not only tell the calculator about the annual cash flows, but also the cost (previously, we set the cost to 0 because we just wanted the present value of the cash flows). Generally speaking, you’ll pay for an investment before you can receive its benefits so the cost (initial outlay) is said to occur at time period 0 (i.e., today). To find the NPV or IRR, first clear the cash flow registers and then enter -800 into FLOW (0), then enter the remaining cash flows exactly as before. With all of the cash flows entered, press CALC and then enter 12 into I% (actually, it should already be there from before) and then press NPV. You’ll find that the NPV is \$200.17922.

Example 4.1 — Internal Rate of Return

Solving for the IRR is done exactly the same way, except that the discount rate is not necessary. This time, you’ll press IRR% to find that the IRR is 19.5382%.

Example 4.2 — Modified Internal Rate of Return

The IRR has been a popular metric for evaluating investments for many years — primarily due to the simplicity with which it can be interpreted. However, the IRR suffers from a couple of serious flaws. The most important flaw is that it implicitly assumes that the cash flows will be reinvested for the life of the project at a rate that equals the IRR. A good project may have an IRR that is considerably greater than any reasonable reinvestment assumption. Therefore, the IRR can be misleadingly high at times.

The modified internal rate of return (MIRR) solves this problem by using an explicit reinvestment rate. Unfortunately, most financial calculators don’t have an MIRR key like they have an IRR key. That means that we have to use a little ingenuity to calculate the MIRR. Fortunately, it isn’t difficult. Here are the steps in the algorithm that we will use:

1. Calculate the total present value of each of the cash flows, starting from period 1 (leave out the initial outlay). Use the calculator’s NPV function just like we did in Example 3, above. Use the reinvestment rate as your discount rate to find the present value.
2. Calculate the future value as of the end of the project life of the present value from step 1. The interest rate that you will use to find the future value is the reinvestment rate.
3. Finally, find the discount rate that equates the initial cost of the investment with the future value of the cash flows. This discount rate is the MIRR, and it can be interpreted as the compound average annual rate of return that you will earn on an investment if you reinvest the cash flows at the reinvestment rate.

Suppose that you were offered the investment in Example 3 at a cost of $800.  What is the MIRR if the reinvestment rate is 10% per year?

Let’s go through our algorithm step-by-step:

1. The present value of the cash flows can be found as in Example 3, but this time we are using the reinvestment rate to discount the cash flows. Enter the CFLO menu and then clear the cash flow registers: Press SHIFT INPUT, and then choose YES when prompted. The calculator will now prompt you for the cash flows for each period, and the frequency of those cash flows. For now, make sure each #TIMES prompt is set to 1 as you enter your cash flows. All you need to do is to enter the cash flows from the above list when prompted (remember that we are ignoring the cost of the investment at this point, so FLOW(0) should be 0). Use the INPUT key to enter the numbers. Once all of the cash flows are entered, press EXIT to get to another menu. Choose CALC (calculate). On the CALC menu, we first need to enter 10 into I%. Finally, press NPV to find that the present value is \$1,065.26.
2. Press EXIT and return to the TVM menu. To find the future value of the cash flows, enter -1,065.26 into PV, 5 into N, and 10 into I%YR. Now press FV and see that the future value is \$1,715.61.
3. At this point our problem has been transformed into an \$800 investment with a lump sum cash flow of \$1,715.61 at period 5. The MIRR is the discount rate (I%YR) that equates these two numbers. Enter -800 into PV and then press I%YR. The MIRR is 16.48% per year.

So, we have determined that our project is acceptable at a cost of \$800. It has a positive NPV, the IRR is greater than our 12% required return, and the MIRR is also greater than our 12% required return.

Please continue on to the next page to learn how to solve problems involving non-annual periods.