{[ promptMessage ]}

Bookmark it

{[ promptMessage ]}

chapter6A - Chapter 6 NPV versus its Competitors Example...

Info iconThis preview shows pages 1–7. Sign up to view the full content.

View Full Document Right Arrow Icon
Chapter 6 NPV versus its Competitors
Background image of page 1

Info iconThis preview has intentionally blurred sections. Sign up to view the full version.

View Full Document Right Arrow Icon
Example: Net Present Value The Alpha Corporation is considering investing in a riskless project costing $100. The project receives $107 in one year and has no other cash flows. The discount rate is 6 percent. NPV of the project = The basic investment rule: Accept if the NPV is greater than zero Reject if the NPV is less than zero How do we interpret the NPV of $.94?
Background image of page 2
Overview Key features of NPV rule: Competitors 1. Payback period rule and discounted payback rule 2. Average accounting return 3. The internal rate of return
Background image of page 3

Info iconThis preview has intentionally blurred sections. Sign up to view the full version.

View Full Document Right Arrow Icon
Payback period method Payback period = number of years before expected cash flows equal initial outlay Payback rule: Accept all projects with a payback period shorter than some cutoff Example: Project C 0 C 1 C 2 C 3 C4 Payback NPV at period r=.10 A -100 50 50 0 60 2 21.52 B -100 50 30 20 60 3 26.26 C -100 30 50 20 60,000 3 40,966.08
Background image of page 4
Problems: (1) ignores the time value of money within the payback period (2) totally ignores payments after the payback period (3) cutoff date is arbitrary Set it short tend to reject positive NPV projects Set it long tend to accepts negative NPV projects Firms often set cutoff date by guesswork based on a “typical” projects cash flow pattern
Background image of page 5

Info iconThis preview has intentionally blurred sections. Sign up to view the full version.

View Full Document Right Arrow Icon
A “slight” improvement – discounted payback How does this work? First discount all cash flows from a project Calculate payback period for discounted cash flows Accept project if discounted payback period < cutoff Why would firms ever use such silly rules?
Background image of page 6
Image of page 7
This is the end of the preview. Sign up to access the rest of the document.

{[ snackBarMessage ]}