Chapter 9
Net Present Value and Other
Investment Criteria
Slide 9 - 1
■
Capital Budgeting Decisions
Capital budgeting decision is also called investment decision,
which involves such issues as:
●
Whether or not to invest in a particular project?
●
When faced with several projects and limited resources, pick
the best project to invest in.
We discuss these issues in Chapter 9, 10, and 11.
Concept of Capital Budgeting
Slide 9 - 2
Good Decision Criteria
■
Evaluate Decision Rules
To evaluate capital budgeting decision rules, we need to ask
ourselves the following questions:
●
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?
Slide 9 - 3
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An Example
A factory costs $400,000. You forecast that it will produce cash inflows
of $120,000 in year 1, $180,000 in year 2, and $300,000 in year 3. The
discount rate is 12 percent. Is the factory a good investment?
We need to compare the cost and the benefit of the investment. To do so,
we convert all cash flows to time 0 (or to any time point).
The present value of all cash inflows, $464,171.83, is more than the
present value of cash outflow, $400,000. The factory is a good investment.
The net benefit $64,171.83 is the
Net Present Value
of this investment.
83
.
171
,
464
$
12
.
1
000
,
300
$
12
.
1
000
,
180
$
12
.
1
000
,
120
$
PV
000
,
400
$
PV
3
2
benefit
cost
=
+
+
=
=
Net Present Value: Concept