Chapter_09_Presentation - 9 Net Present Value and Other...

Info iconThis preview shows pages 1–10. Sign up to view the full content.

View Full Document Right Arrow Icon
9 Net Present Value and Other Investment Criteria
Background image of page 1

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

View Full DocumentRight Arrow Icon
9-2 Good Decision Criteria Good Decision Criteria We need to ask ourselves the following questions when evaluating capital budgeting decision rules Does the decision rule adjust for the time value of money? Does the decision rule adjust for risk? Does the decision rule provide information on whether we are creating value for the firm?
Background image of page 2
9-3 Project Example Information Project Example Information You are looking at a new project and you have estimated the following cash flows: Year 0:CF = -165,000 Year 1:CF = 63,120; NI = 13,620 Year 2:CF = 70,800; NI = 3,300 Year 3:CF = 91,080; NI = 29,100 Average Book Value = 72,000 Your required return for assets of this risk is 12%.
Background image of page 3

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

View Full DocumentRight Arrow Icon
9-4 Net Present Value: Net Present Value: NPV=PV(cash flows) – initial cost NPV=PV(cash flows) – initial cost The difference between the market value of a project and its cost How much value is created from undertaking an investment? This is measured by taking the present value of the future cash flows and subtracting the initial cost. If NPV>0, then the project is worthwhile; it adds value. The rate used to discount the cash flows must be appropriate for the level of risk of the cash flows (more on this in Chapter 15).
Background image of page 4
9-5 Computing NPV for the Project Computing NPV for the Project Using the formulas: NPV = 63,120/(1.12) + 70,800/(1.12) 2 + 91,080/(1.12) 3 – 165,000 = 12,627.42 Using the calculator: CF 0 = -165,000; C01 = 63,120; F01 = 1; C02 = 70,800; F02 = 1; C03 = 91,080; F03 = 1; NPV; I = 12; CPT NPV = 12,627.42 Since NPV is positive, accept the project.
Background image of page 5

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

View Full DocumentRight Arrow Icon
9-6 Decision Criteria Test - NPV Decision Criteria Test - NPV Does the NPV rule account for the time value of money? Yes. Does the NPV rule account for the risk of the cash flows? Yes. Does the NPV rule provide an indication about the increase in value? Yes. Should we consider the NPV rule for our primary decision rule? Yes.
Background image of page 6
9-7 Payback Period Payback Period How long does it take to get the initial cost back in a nominal sense, i.e. ignoring time value of money and discount rates? Computation Estimate the cash flows Subtract the future cash flows from the initial cost until the initial investment has been recovered Decision Rule – Accept if the payback period is less than some preset limit
Background image of page 7

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

View Full DocumentRight Arrow Icon
9-8 Computing Payback For The Project Computing Payback For The Project Assume we will accept the project if it pays back within two years. Year 1: 165,000 – 63,120 = 101,880 still to recover Year 2: 101,880 – 70,800 = 31,080 still to recover Year 3: 31,080 – 91,080 = -60,000 project pays back in year 3 We reject the project because we still had $31,080 to recover after year 2.
Background image of page 8
9-9 Decision Criteria Test - Payback Decision Criteria Test - Payback Does the payback rule account for the time value of money? No. Does the payback rule account for the risk of
Background image of page 9

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

View Full DocumentRight Arrow Icon
Image of page 10
This is the end of the preview. Sign up to access the rest of the document.

Page1 / 35

Chapter_09_Presentation - 9 Net Present Value and Other...

This preview shows document pages 1 - 10. Sign up to view the full document.

View Full Document Right Arrow Icon
Ask a homework question - tutors are online