project a good investment? Second, if we have more than one good project, but we can
take only one of them, which one should we take? The main point of this chapter is that
only the NPV criterion can always provide the correct answer to both questions.
For this reason, NPV is one of the two or three most important concepts in finance,
and we will refer to it many times in the chapters ahead. When we do, keep two things
in mind: (1) NPV is always just the difference between the market value of an asset or
project and its cost, and (2) the financial manager acts in the shareholders’ best interests
by identifying and taking positive NPV projects.
Finally, we noted that NPVs can’t normally be observed in the market; instead, they
must be estimated. Because there is always the possibility of a poor estimate, financial
managers use multiple criteria for examining projects. The other criteria provide addi
tional information about whether or not a project truly has a positive NPV.
9.1
Investment Criteria
This problem will give you some practice calculating
NPVs and paybacks. A proposed overseas expansion has the following cash
flows:
Calculate the payback, the discounted payback, and the NPV at a required return
of 10 percent.
9.2
Mutually Exclusive Investments
Consider the following two mutually exclu
sive investments. Calculate the IRR for each and the crossover rate. Under what
circumstances will the IRR and NPV criteria rank the two projects differently?
9.3
Average Accounting Return
You are looking at a threeyear project with
a projected net income of $2,000 in Year 1, $4,000 in Year 2, and $6,000 in
Year 3. The cost is $12,000, which will be depreciated straightline to zero over
the threeyear life of the project. What is the average accounting return (AAR)?
9.1
In the following table, we have listed the cash flow, cumulative cash flow, dis
counted cash flow (at 10 percent), and cumulative discounted cash flow for the
proposed project.
Answers to Chapter Review and SelfTest Problems
Year
Investment A
Investment B
0
$75
$75
1
20
60
2
40
50
3
70
15
Year
Cash Flow
0
$200
1
50
2
60
3
70
4
200
Chapter Review and SelfTest Problems
CHAPTER 9
Net Present Value and Other Investment Criteria
301
This preview has intentionally blurred sections. Sign up to view the full version.
View Full Document
Recall that the initial investment was $200. When we compare this to accu
mulated undiscounted cash flows, we see that payback occurs between Years 3
and 4. The cash flows for the first three years are
$180
total, so, going into the
fourth year, we are short by $20. The total cash flow in Year 4 is
$200
, so the
payback is 3
($20/200)
3.10 years
.
Looking at the accumulated discounted cash flows, we see that the dis
counted payback occurs between Years 3 and 4. The sum of the discounted cash
flows is
$284.23
, so the NPV is
$84.23
. Notice that this is the present value of
the cash flows that occur after the discounted payback.
This is the end of the preview.
Sign up
to
access the rest of the document.
 Spring '08
 mikson
 Net Present Value

Click to edit the document details