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UGBA 103: Introduction to Finance
Lecture 8 (2/25/08)
MIDTERM #1
Covers
chapters 16
2 parts:
1.
Problems in back in chapter, ex. PV calculations
2.
Problems based on slides
5 questions, each question 5% of ending grade
3 questions from end of chapter
2 draw on slides in class, cover material not in the questions in the book
If send email about exam, will not provide any information
Need to ask in presence of everyone
NEED TO BRING CACULATOR! Graphing calculators are okay
Need to write out
all equations
Show simplified formula, then fill in numbers in caculator
Closed book exam, no cheat sheets
Get partial credit if you don
’
t answer questions right
EXAM STARTS 8:10
SLIDES: INVESTMENT DECISION RULES (CHAPTERS 67)
Payback
IRR internal rate of return
EVA similar to PV
PAYBACK RULE
PV not easy to apply
Simplest popular investment decision rule
Selects a time, ex. 4 years. Certain profits come back (net cash flows) which can be thought as paying
back initial investment. Ex. Companies say we only take on projects that have payback 5 years or less.
DIFFCULTIES WITH PAYBACK
Better as way to screen investments.
1.
Where did 5 years come from? Arbitrary, It could be 3 years, 4 years, 5 years. For most
companies it probably comes from experience.
2.
Ignores time value of money for the payments before the breakeven date.
3.
’
t see good
return until 5
th
year
REDEEMING FEATURES
Good for small projects not that important to firm
Corrects for a couple of things:
Issues of liquidity
—
if get paybacks early, can turn around and use money for something else, ex.
New investment
Considers flexibility option (NPV can do this, but harder)
Cash flows in short run easier to show than long run, so payback rule shows those easier to project
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View Full Document INTERNAL RATE OF RETURN: DEFINITION
(THIS SLIDE GOES BEYOND TEXT!!!!)
C
0
= start of investment
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This note was uploaded on 05/11/2008 for the course UGBA 103 taught by Professor Berk during the Spring '07 term at University of California, Berkeley.
 Spring '07
 Berk

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