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

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Faculty of Business and Economics University of Hong Kong Dr. T. Lin Chapter 9: Net Present Value and Other Investment Criteria
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Capital Budgeting 2 9 Investment Criteria 2, 10 Discounted Cash Flow 11 Sensitivity Analysis 14 Cost of Capital
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Commonly Used Investment Criteria 3 Net Present Value Internal Rate of Return Profitability Index The Payback Rule The Discounted Payback The Average Accounting Return
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Example: Project x 4 Suppose a proposed project is expected to generate the following cash flows: Year 0 - 20,000 Year 1 50,000 Year 2 30,000 Year 3 - 70,000 Your required return is 10% per year.
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Net Present Value Rule 5 NPV is calculated with DCF valuation. NPV = PV (future cash flows) Initial Investment. Accept a project if its NPV > 0 Reject a project if its NPV < 0 What if NPV = 0?
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What is the NPV value? 6 What do you think we should do? 2 3 $50,000 $30,000 $70,000 $20,000 1.1 1.1 1.1 $234.41 NPV  
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The Internal Rate of Return 7 Internal: determined by the cash flow process completely. IRR is the discount rate that will yield a zero for the NPV calculation. Accept IRR if it is greater than your required return. 0 ) 1 ( 000 , 70 ) 1 ( 000 , 30 1 000 , 50 000 , 20 3 2 r r r
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What is the IRR in our example?
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