L_10 - Lecture 10 Net Present Value and Other Investment...

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Lecture 10 Net Present Value and Other Investment Criteria Lecture Organization Annuity and perpetuity Net Present Value The Payback Rule The Discounted Payback IRR
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Example: Perpetuity Calculations What is the present value of cash flow of $1000 per year forever . This is called a perpetuity PV of perpetuity is easy to calculate: PV = C / r PV= $1000/.06 = $16,666.66… 0 $1,000 $1,000 $1,000 Year, t Perpetuity ….. $1,000
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Growing Perpetuity Calculations What is the present value of cash flow of the growing perpetuity PV of perpetuity is easy to calculate: PV of Growing Perpetuity = C /( r-g) PV= $1000/(.06 – 0.02)= $25,000.00 0 $1,000 $1,000(1+g) $1,000*(1+g) 2 Year, t ….. $1,000(1+g) 3
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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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The NPV Rule Net present value the difference between the present (market) value of an investment and its cost. Net present value rule an investment should be accepted if the NPV is positive and rejected if it is negative.
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NPV Illustrated Assume you have the following information on Project X: Initial Investment (initial Outlay) -$1,100 Required return = 10% Annual cash revenues and expenses are as follows: Year Revenues Expenses 1 $1,000 $500 2 2,000 1,000 Draw a time line and compute the NPV of project X.
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NPV Illustrated (concluded) 0 1 2 Initial Investment ($1,100) Revenues $1,000 Expenses 500 Cash flow $500 Revenues $2,000 Expenses 1,000 Cash flow $1,000
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NPV Illustrated (concluded) 0 1 2 Initial Investment
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L_10 - Lecture 10 Net Present Value and Other Investment...

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