L_11 - Lecture 11 Net Present Value and Other Investment...

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Lecture 11 Net Present Value and Other Investment Criteria Lecture Organization IRR Incremental Cash Flows
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The Capital Budgeting Decisions: "What Assets Should We Buy?" “What investment Should We Choose? Is given investment project worthwhile to undertake? There are several approaches (rules) to answer these Questions: Net Present Value Payback Rule (Ordinary and Discounted Payback) Profitability Index Internal Rate of Return Average Accounting Return
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Internal Rate of Return Internal rate of return (IRR) —rate that makes the present value of the future cash flows equal to the initial cost of investment. In other words, the discount rate that gives a project a $0 NPV. IRR rule —investment is acceptable if and only if the IRR exceeds the required return.
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Problems with the IRR and its Disadvantages Multiple rates of return —if cash flows alternate back and forth between positive and negative (in and out), more than one IRR is possible. Mutually exclusive investment decisions —if taking one project means another is not taken, the projects are mutually exclusive. The one with the highest IRR may not be the one with the highest NPV. IRR
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Assume you are considering a project for which the cash flows are as follows: Year Cash flows 0 -$252 1 1,431 2 -3,035 3 2,850 4 -1,000 Multiple Rates of Return What’s the IRR? Find the rate at which the computed NPV = 0.
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Multiple Rates of Return (concluded) $0.06 $0.04 $0.02 $0.00 ($0.02) NPV ($0.04) ($0.06) ($0.08) 0.2 0.28 0.36 0.44 0.52 0.6 0.68 IRR = 25% IRR = 33.3% IRR = 42.86% IRR = 66% Discount rate at 25.00%: NPV = 0 at 33.33%: NPV = 0 at 42.86%: NPV = 0 at 66.67%: NPV = 0
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L_11 - Lecture 11 Net Present Value and Other Investment...

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