LECTURE6

LECTURE6 - Lecture 6 Lecture Alternative Investment Rules...

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Lecture 6 Lecture 6 Alternative Investment Rules Alternative Investment Rules
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The NPV Rule, a review Three key features of the NPV criterion NPV uses cash flows NPV uses all the cash flows of a project NPV discounts future cash flows A firm operating in the interests of its shareholders should accept investment projects if and only if they have positive NPV
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The Payback Period Rule Accepts all and only those projects that have a payback period less than or equal to an arbitrary “cutoff” point Example : Example : Consider the following projects X and Y Project C0 C1 C2 C3 Payback Period X -1000 1000 0 0 1 year Y -1000 500 500 2000 2 year NPV ’s for X and Y if the discount rate is 12% ( 29 ( 29 59 . 1268 12 . 1 2000 12 . 1 500 12 . 1 500 1000 14 . 107 12 . 1 1000 1000 3 2 = + + + - = - = + - = Y NPV X NPV The payback period is the number of years it takes before the sum of undiscounted cash flows from the project becomes positive
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The Payback Period Rule (continued) Managerial perspective : Use the payback rule only for minor decisions with shorter horizons and when the quality of decision making is easy to evaluate. Discounted Payback Rule : It is based on the number of years required for the discounted cash flows to equal initial investment. Problems
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This note was uploaded on 12/20/2011 for the course ECON 448 taught by Professor Bejan during the Spring '06 term at Rice.

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LECTURE6 - Lecture 6 Lecture Alternative Investment Rules...

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