FINE 2000 Chapter 9 NPV and Other Investment Criteria.docx...

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FINE 2000: Chapter 9 Net Present Value and Other Investment Criteria 9.1 Net Present Value Basic Idea - Investment is worth undertaking if it creates value for its owners o Worth more in the marketplace than its cost to acquire - Capital budgeting: trying to determine whether proposed investment or project will be worth more than it costs once it is in place - Net Present Value: difference between an investment’s market value and its cost o Ex. Market value of a home is 100,000 and the cost to purchase and renovate it is 90,000, then 10,000 is your NPV o How much value is added today by undertaking an investment o Goal is to search for positive NPV projects Estimating Net Present Value - If there is no marketplace to compare to (e.g. housing market), we must estimate NPV by estimating the future cash flows that we expect the new business to produce o NPV is the difference between the PV of the future cash flows and the cost of the investment - $6,000 in net cash flows for 8 years, lump sum of $2,000 at the end of 8 years - What is the Present Value? o o What is the Net Present Value? NPV = Investment market Value – Cost paid NPV =– 27,578 + 30,000 = -2422 NOT A GOOD INVESTMENT - Net Present Value rule: an investment should be accepted if the NPV is positive and rejected if it negative - NPV figure itself tells us how much value will be created with the investment 9.2 The Payback Rule (shitty) - Payback Period (accounting breakeven):

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