Chapter 5 - Chapter 5 Why NPV leads to better decisions...

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Chapter 5: Why NPV leads to better decisions than other criteria. .. Suppose a manager asks how to decide whether to invest in project X "First forecast the cash flows generated by project X; second, determine the appropriate opportunity cost (rate of discount, required rate of return, etc.) that reflects both the time value of money and the systematic risk involved in project X. Third, use this opportunity cost of capital to discount the future cash flows. Fourth, calculate NPV. Invest in X if NPV > 0." He asks why. .. If NPV>0, then investing in X is best for the stockholders How will positive NPV show up in stock price? Answer; investors aren't stupid. .. Where does the discount rate come from? Answer: look at what the stock market does. From shareholders' point of view, the true opportunity cost is that we give them back the money--and they then invest it in the market. Competitors to NPV Payback period--gives equal weight to all cash flows, even those far in the future Discounted payback--better, but still short-sighted
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Chapter 5 - Chapter 5 Why NPV leads to better decisions...

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