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Chapter 9NET PRESENT VALUE AND OTHER INVESTMENT CRITERIANet Present ValueThe Basic IdeaNet present value – the difference between the market value of an investment and its cost. Estimating cost is usually straightforward; however, finding the market value of assets can be tricky. Estimating Net Present Value (We’ve done this!!)Discounted cash flow (DCF) valuation – finding the market value of assets or their benefits by taking the present value of future cash flows, i.e., by estimating what the future cash flows would trade for in today’s dollars.NPV=∑[CFi /(1+WACC)^i] - Cost
Chapter 9NET PRESENT VALUE AND OTHER INVESTMENT CRITERIAThe Payback RulePayback period – length of time until the accumulated cash flows equal or exceed the original investment.Payback period rule – investment is acceptable if its calculated payback is less than some prespecified number of years.
Chapter 9NET PRESENT VALUE AND OTHER INVESTMENT CRITERIAThe Payback RuleAnalyzing the Rule-No discounting involved-Doesn’t consider riskdifferences-How is the cutoff point determined?-Bias for short-term investmentsRedeeming Qualities of the Rule-Simple to use-Bias for short-term promotes liquidity