ActSc371_Lecture 15_Chapter 7 (Ross)

# ActSc371_Lecture 15_Chapter 7 (Ross) - ActSc 371 Corporate...

This preview shows pages 1–6. Sign up to view the full content.

Lecture 15 Sections 7.1-7.3: Net Present Value and Other Investment Rules(Corporate Finance by Ross et al.) ActSc 371 – Corporate Finance 1 Instructor: Dr. Lysa Porth 1

This preview has intentionally blurred sections. Sign up to view the full version.

View Full Document
Introduction A corporate project generating a set of cash flows can be valued by discounting these flows, an approach called the net present value (NPV) approach. We believe that the NPV approach is the best for evaluating capital budgeting projects. There are also other alternative methods: payback Accounting rate of return Internal rate of return Profitability index
7.1 Why Use Net Present Value The basic investment rule can be generalized to: Accept a project if the NPV is greater than zero. Reflect a project if NPV is less than zero. Formula for NPV: ( 29 ( 29 ( 29 n n r C r C r C r C C NPV + + + + + + + + + = 1 1 1 1 3 3 2 2 1 0

This preview has intentionally blurred sections. Sign up to view the full version.

View Full Document
Example: The Alpha Corporation is considering investing in a riskless project costing \$100. The project receives \$107 in one year and has no other cash flows. The interest rate is 6 percent. The NPV of the project can easily be calculated as \$0.94=-\$100+\$107/1.06 We know that the project should be accepted since its NV is positive. Had the NPV of the project been negative, as would have been the case with an interest rate greater than 7 percent, the project should be rejected.
Why does the NPV rule lead to a good decision? Consider the following two statements: 1. Use \$100 of corporate cash to invest in the project. The \$107 will be paid as a dividend in one year. 2. Forgo the project and pay the \$100 of corporate cash as a dividend today.

This preview has intentionally blurred sections. Sign up to view the full version.

View Full Document
This is the end of the preview. Sign up to access the rest of the document.

{[ snackBarMessage ]}

### What students are saying

• As a current student on this bumpy collegiate pathway, I stumbled upon Course Hero, where I can find study resources for nearly all my courses, get online help from tutors 24/7, and even share my old projects, papers, and lecture notes with other students.

Kiran Temple University Fox School of Business ‘17, Course Hero Intern

• I cannot even describe how much Course Hero helped me this summer. It’s truly become something I can always rely on and help me. In the end, I was not only able to survive summer classes, but I was able to thrive thanks to Course Hero.

Dana University of Pennsylvania ‘17, Course Hero Intern

• The ability to access any university’s resources through Course Hero proved invaluable in my case. I was behind on Tulane coursework and actually used UCLA’s materials to help me move forward and get everything together on time.

Jill Tulane University ‘16, Course Hero Intern