chap9

# chap9 - Chapter 9 Chapter Net Present Value and Net Other...

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Chapter 9 Chapter 9 Net Present Value and Net Present Value and Other Investment Criteria Other Investment Criteria

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9-2 FIN 3716 Key Concepts and Skills Key Concepts and Skills Be able to compute payback and discounted payback and understand their shortcomings Understand accounting rates of return and their shortcomings Be able to compute the internal rate of return and understand its strengths and weaknesses Be able to compute the net present value and understand why it is the best decision criterion
9-3 FIN 3716 Chapter Outline Chapter Outline Net Present Value The Payback Rule The Discounted Payback The Average Accounting Return The Internal Rate of Return The Profitability Index The Practice of Capital Budgeting

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9-4 FIN 3716 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?
9-5 FIN 3716 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%.

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9-6 FIN 3716 Net Present Value 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.
9-7 FIN 3716 NPV – Decision Rule 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.

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9-8 FIN 3716 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 = 12,627.41 Do we accept or reject the project?
9-9 FIN 3716 Decision Criteria Test - NPV 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

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## This note was uploaded on 12/14/2010 for the course FIN 3716 taught by Professor Fang during the Fall '10 term at LSU.

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chap9 - Chapter 9 Chapter Net Present Value and Net Other...

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