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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
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Internal Rate of Return Internal rate of return (IRR) IRR rule
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Internal Rate of Return Illustrated Initial Investment = -$200 Year Cash flow 1 $ 50 2 100 3 150 Find the IRR such that NPV = 0 50 100 150 0= - 200 + + + (1+IRR) 1 (1+IRR) 2 (1+IRR) 3
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Internal Rate of Return Illustrated (concluded) NPV = - 200 + 50/ (1+IRR) 1 + 100/(1+IRR) 2 + 150/(1+IRR) 3 Trial and Error Discount rates NPV 0% 5% 10% 15% 20%
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Problems with the IRR and its Disadvantages Multiple rates of return Mutually exclusive investment decisions 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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