Excel Best Practices and Functions

Effective Annual Rates when Loan Interest is Paid

The term “effective annual rate” (EAR) is very often explained with reference to the compounding of a nominal or stated rate using the formula: For example, if the stated rate is 12% p.a., compounded quarterly, then the EAR is (1.03)^4 -1 i.e. around 12.6% p.a. These explanations are potentially ambiguous, since they do not make …

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Using Risk Modelling and Monte Carlo Simulation in Cash Flow Valuation: Role and Benefits

Since 1989, I have been using risk modelling combined with Monte Carlo simulation to improve the robustness, transparency and accuracy of cash flow valuation models. This powerful approach is still underused for reasons that can be debated elsewhere. Here, I briefly summarise the key reasons that drive the improvement in the valuation when using such …

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Some Challenges in Using IRR in Decision Support (Part I)

The use of the internal rate of return in decision-making can be rather subtle and may even be misleading. For example, the decision rule: “For independent projects, accept the project if the IRR is above the required rate of return” is often stated as the core rule. However, the following demonstrates the general principle that …

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