{[ promptMessage ]}

Bookmark it

{[ promptMessage ]}

Chap009s

# Chap009s - Net Present Value and Other Investment Criteria...

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

Net Present Value and Other Investment Criteria Chapter 9 1

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

View Full Document
Good Decision Criteria We need to ask ourselves the following questions when evaluating decision criteria 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? 2
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%. 3

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

View Full Document
Net Present Value The difference between the market value of a project and its cost How much value is created from undertaking an investment? The first step is to estimate the expected future cash flows. The second step is to estimate the required return for projects of this risk level. The third step is to find the present value of the cash flows and subtract the initial investment. 4
NPV – Decision Rule If the NPV is positive, accept the project A positive NPV means that the project is expected to add value to the firm and will therefore increase the wealth of the owners. Since our goal is to increase owner wealth, NPV is a direct measure of how well this project will meet our goal. 5

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

View Full Document
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 Do we accept or reject the project? 6
Decision Criteria Test - NPV Does the NPV rule account for the time value of money? Does the NPV rule account for the risk of the cash flows? Does the NPV rule provide an indication about the increase in value? Should we consider the NPV rule for our primary decision criteria? 7

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

View Full Document
Payback Period How long does it take to get the initial cost back in a nominal sense? 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 8
Computing Payback For The Project Assume we will accept the project if it pays back within two years.

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

View Full Document
This is the end of the preview. Sign up to access the rest of the document.

{[ snackBarMessage ]}