Lecture 26 - Business Finance (ACC501) Lesson 26 Review of...

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136 Business Finance (ACC501) Lesson 26 Review of the Previous Lecture Preferred Stock Features The Stock Market Net Present Value Estimating NPV Topics under Discussion Net Present Value Using NPV The Payback Rule Average Accounting Return Using NPV Given that the goal of financial management is to increase the share value, we have the net present value rule An investment should be accepted if the net present value is positive and rejected if it is negative.” In the unlikely event that NPV is turned out to be zero, we would be indifferent between taking and not taking the investment Two comments The task of coming up with cash flows and the discount rate is much more important than the process of discounting itself. The process of discounting cash flows would only give us an estimated figure of NPV. The true NPV can be found by putting the investment for sale and see what we got for it. Suppose we are asked to decide whether or not a new product be launched. Based on projected costs and sales, we expect that the cash flows over the 5-year life of the project will be $2,000 in first two years, $4,000 in the next two and $5,000 in the last year. It would cost about $10,000 to begin production. Given a 10% discount rate, what should we do? The total value of the product by discounting its cash flow to present: PV = $2,000/1.1 + 2,000/1.1 2 + 4,000/1.1 3 + 4,000/1.1 4 + 5,000/1.1 5 = $1,818 + 1,653 + 3,005 + 2,732 + 3,105 = $12,313 The present value of the expected cash flows is $12,313, but the cost of getting those cash flows is $10,000 so the NPV is $12,313 – 10,000 = $2,313
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This note was uploaded on 08/04/2011 for the course ACCT 501 taught by Professor Na during the Spring '11 term at Virtual University of Pakistan.

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Lecture 26 - Business Finance (ACC501) Lesson 26 Review of...

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