InvestmentCriteria

# InvestmentCriteria - InvestmentCriteria InvestmentCriteria...

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Investment Criteria FINC 3610 Yost Investment Criteria 204 Net Present Value (NPV) What : NPV is a measure of how much value is created or added today by undertaking an investment (the difference between the investment’s market value 205 between the investment s market value and its cost). How : Estimate future cash flows. Calculate the present value of those cash flows minus the initial cost. NPV Example You plan to buy a machine that will cost \$2,000 today and produce cash flows of \$1,500 in each of the next two years. The salvage value will be zero The cost of capital 206 salvage value will be zero. The cost of capital is 15 percent. Should you buy the machine?

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Investment Criteria FINC 3610 Yost Net Present Value (NPV) The Rule : An investment should be accepted if the net present value is positive and rejected if it is negative. *Assumes cash flows are reinvested at _____________________. 207 Pros: 1. 2. Cons: 1. 2. Internal Rate of Return (IRR) What : The internal rate of return is the discount rate that makes the net present value of a project equal to zero. 208 How : Set NPV equal to zero and solve for “r”. Calculating IRR is identical to calculating the yield to maturity on bonds. IRR Example You plan to buy a machine that will cost \$2,000 today and produce cash flows of \$1,500 in each of the next two years. The salvage value will be zero The cost of capital 209 salvage value will be zero. The cost of capital is 15 percent. Should you buy the machine?
Investment Criteria FINC 3610 Yost Internal Rate of Return (IRR) The Rule : An investment is acceptable if the IRR exceeds the required rate of return. It should be rejected otherwise. *Assumes cash flows are reinvested at ______________________. Pros 210 Pros: 1. 2. Cons: 1. 2. Net Present Value Profile What is it? 211 What information does it provide? 1. 2. 3. 4. Internal Rate of Return (IRR) BEWARE – Nonconventional Cash flows Example: Assume you are considering a project with the following cash flows: 212 Year Cash Flows 0 \$ 252 1 \$1,431 2 \$3,035 3 \$2,850 4 \$1,000

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Investment Criteria FINC 3610 Yost Internal Rate of Return (IRR) Calculate the NPV: at 25.00%: NPV = _______________ at 33.33%: NPV = _______________ 213 at 42.86%: NPV = _______________ at 66.67%: NPV = _______________ What’s the IRR?
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## This note was uploaded on 12/11/2011 for the course FINC 3610 taught by Professor Yost during the Fall '08 term at Auburn University.

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InvestmentCriteria - InvestmentCriteria InvestmentCriteria...

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