Finc312StudyGuide1 - CH 12 Payback easy to calculate...

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CH 12 Payback - easy to calculate, understand; does not take into account time value of money or cash flows beyond payback period Discounted Payback – takes into account time value of money and if discounted payback is positive, then project is feasible; provides sense of liquidity and risk – does not take into account cash flows beyond payback period hence could lead to mistakes with exclusive project Accounting Rate of Return – finds average income over project’s life and divides income by average investment of project (TVM – not accounted) N PV – most logical method, most consistent with value maximization IRR – “reasonable” method that accepts/rejects decisions for independent projects; ranking of mutually exclusive projects can differ because of different size of project or different timing of cash flows MIRR – not widely used, but actually superior to IRR, do not have to use WACC if there is reason to think actual reinvestment rate will differ, Better because gives better estimate of rate of return an investment will earn over its lifetime (no multiple MIRRs, NPV and MIRR will agree if based on WACC) PI – dollars of profit per dollar of cost, considers cash flows over life of the project, can conflict NPV for mutually exclusive projects that differ in size 12.1 Capital budgeting – process to indentify projects that add to the firm’s value Six Key Methods: NPV, IRR, MIRR, PI, Payback, Discounted Payback First and most difficult step of project analysis is estimating cash flows 12.2 - NPV NPV = CF(0)+ {CF(1)/(1+r)^1} + {CF(2)/(1+r)^2} + … + {CF(N)/(1+r)^N} Based on Discounted Cash Flow (DCF) technique
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Mutually exclusive – if the project is taken on, the other must be rejected Independent projects – cash flows are independent of each other NPV of zero signifies that the project’s cash flows are equally sufficient to repay the invested capital and provide Required Rate of Return If NPV is positive, excess cash accrues solely to the firm’s shareholders NPV is also equal to the present value of the project’s future EVA (Economic Value Added) Therefore accepting a positive NPV will result in a positive EVA and MVA (Market Added Value) Rate in which cash flows can be reinvested is the cost of capital 12.3 - IRR IRR = the project’s expected return, defined as the discount rate that forces NPV to equal zero CF(0)+ {CF(1)/(1+IRR)^1} + {CF(2)/(1+IRR)^2} +…+ {CF(N)/ (1+IRR)^N} = 0 Without a financial calculator, find IRR using trial and error (tedious) Calculator: IRR enter cash flows Hurdle Rate – also known as cost of capital NPV and IRR can give conflicting rankings for mutually exclusive projects Rate in which cash flows can be reinvested is the IRR 12.4 – NPV vs. IRR Net Present Value Profile – graph that plots NPV against cost of capital Profiles - IRR is where project’s NPV line hits zero (x axis)
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This note was uploaded on 05/02/2010 for the course ACCT Finc314 taught by Professor Depue during the Spring '10 term at University of Delaware.

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Finc312StudyGuide1 - CH 12 Payback easy to calculate...

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