Chapter 9

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

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Net Present Value and ther Investment Rules Other Investment Rules -- Chapter 9 Instructor: Yihui Wang Net Present Value and Other Investment Rules

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Main Issues • How to make investment decisions? • Net Present Value (NPV) rule • The Internal Rate of Return (IRR) • Compare NPV to IRR rule • The practice of capital budgeting Net Present Value and Other Investment Rules 2
Making Investment Decisions • The objective is to increase the firm’s current market value. • A right decision rule should ake into account of the time value of money Take into account of the time value of money Adjust for the risk of the cash flows Provide information on whether we are creating value for ov e o at o o w et e we a e c eat g va ue o the firm Net Present Value and Other Investment Rules 3

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Example • 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 ear 2: F = 70 800; NI = 3 300 Year 2: CF = 70,800; NI = 3,300 Year 3: CF = 91,080; NI = 29,100 Average Book Value = 72,000 ve age oo Va ue 7 ,000 • Your required return for assets of this risk is 12%. ould you take the project or not? Net Present Value and Other Investment Rules Should you take the project or not? 4
Example • Future cash flow generated from the project {CF 1 =63120; CF 2 =70,800; CF 3 =91,080} • Present value of the project 177627 2 91080 2 70800 2 63120 3 2 = + + = PV • Net present value: take out cost ) 12 . 1 ( ) 12 . 1 ( ) 12 . 1 ( + + + Do we accept or reject the project? 12627 165000 177627 cos = = = t PV NPV Net Present Value and Other Investment Rules 5

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Net Present Value • The difference between the market value of a project and its cost h l i t d f d t ki How much value is created from undertaking an investment? 1) estimate the expected future cash flows. 2) estimate the required return for projects of this risk level. d th t l f th h fl d bt t th 3) find the present value of the cash flows and subtract the initial investment. Net Present Value and Other Investment Rules 6
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 al goal. Net Present Value and Other Investment Rules 7

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Decision Criteria Test - NPV • Does the NPV rule account for the time value of money?
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## This note was uploaded on 02/16/2011 for the course ACCT 233 taught by Professor 123 during the Spring '11 term at CUHK.

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

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