95 2 4 00 331 215 3 300 2 25 11 4 100 68 79 3 4 00

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Unformatted text preview: 0 331 (215) 3 300 2 25 11 4 100 68 79 3 4 00 301 (361) 4 6 00 4 10 49 Cash Flows Discounted back at 10%. Uses IF statement. Project L Time period: Cash flow: Disc. cash flow: Disc. cum. cash flow: 0 (1,000) (1,000) (1,000) Discounted Payback: 1 100 91 (909) 3.88 2 300 24 8 (661) Uses IF statement. The inherent problem with both paybacks is that they ignore cash flows that occur after the payback period mark. While the discounted method accounts for timing issues (to some extent), it still falls short of fully analyzing projects. However, all else equal, these two methods do provide some information about projects' liquidity and risk. Net Present Value (NPV) To calculate the NPV, we find the present value of the individual cash flows and find the sum of those discounted cash flows. This value represents the value the project add to shareholder wealth. WACC = 10% Project S Time period: Cash flow: Disc. cash flow: NPV(S) = 0 (1,000) (1,000) $78.82 1 500 4 55 2 4 00 331 3 300 2 25 or $ 78.82 2 300 24 8 = S um disc. CF's. 3 4 00 301 4 100 68 Notice that the NPV function isn't really a Net present value. Instead, it is the present value of future cash flows. Thus, you specify only the future cash flows in the NPV function. To find the true NPV, you must add the time zero cash flow to the result of the NPV function. = Uses NPV function. Project L Time period: Cash flow: Disc. cash flow: NPV(L) = 0 (1,000) (1,000) 1 100 91 $4 9.18 4 6 00 4 10 $ 4 9.18 = Uses NPV function. The NPV method of capital budgeting dictates that all independent projects that have positive NPV should accepted. The rationale behind that assertion arises from the idea that all such projects add wealth, and that should be the overall goal of the manager in all respects. If strictly using the NPV method to evaluate two mutually exclusive projects, you would want to accept the project that adds the most value (i.e. the project with the higher NPV). Hence, if considering the above two projects, you would accept both projects if they are independent, and you would only accept Project S if they are mutually exclusive. Internal Rate of Return (IRR) The internal ra...
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