FIN3210Chapter08 - FIN 3210 Chapter#8 1 Chapter 8 Net...

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FIN 3210 – Chapter #8 1 Chapter 8 – Net Present Value and Other Investment Criteria Payback Period How soon is the initial investment recovered? t A B 0 –$10,000 –$10,000 1 3,000 1,000 2 4,000 2,000 3 5,000 3,000 4 6,000 5,000 5 Advantages: 1. Easy to understand. 2. Adjusts for uncertainty of later cash flows 3. Biased toward liquidity Disadvantages 1. Ignores time value of money 2. Cutoff is arbitrary. 3. Ignores cash flows beyond cutoff date. 4. Biased against long-term projects such as R&D. Average Accounting Return Dumb.
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FIN 3210 – Chapter #8 2 Net Present Value NPV = PV of outflows + PV of inflows If the required return 10 percent, should you accept either project? t X Y 0 –$175,000 –$280,000 1 65,000 100,000 2 85,000 140,000 3 75,000 120,000 4 65,000 80,000 Disadvantages 1. Required return? Advantages 1. Accounts for time value of money. 2. Adjusts for risk. 3. Uses all cash flows. 4. Can be used to rank projects.
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