Find the net present value by taking the difference

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Unformatted text preview: which takes into account the principle of time value of money and the risk-return trade-off 3. Use the discounted cash flow formula and the opportunity cost of capital to calculate the present value of the future cash flows 4. Find the net present value by taking the difference between the present value of future cash flows and the project's costs There exist several other investment rules: - Book rate of return Payback rule Internal rate of return To understand why the net present value rule leads to better investment decisions than the alternatives it is worth considering the desirable attributes for investment decision rules. The goal of the corporation is to maximize firm value. A shareholder value maximizing investment rule is: - Based on cash flows Taking into account time value of money Taking into account differences in risk The net present value rule meets all these requirements and directly measures the value for shareholders created by a project. This is fare from the case for several of the alternative rules. Download free ebooks at bookboon.com 24 Corporate Finance The net present value investment rule The book rate of return is based on accounting returns rather than cash flows: Book rate of return Average income divided by average book...
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