Drawbacks of payback period drawbacks does not

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Unformatted text preview: all of the Does project’s cash flows. project’s (500) 150 150 150 150 150 (300) 0 (500) 0 7 8 0 1 2 3 4 5 6 This project is clearly unprofitable, This unprofitable but we would accept it based on a 4accept year payback criterion! Other Methods Other 1) Net Present Value (NPV) 1) Net 2) Profitability Index (PI) 2) Profitability 3) Internal Rate of Return (IRR) 3) Internal Each of these decision-making criteria: Examines all net cash flows, Considers the time value of money, and Considers the required rate of return. Net Present Value Net • NPV = the total PV of the annual net NPV cash flows - the initial outlay. cash n NPV = Σ t=1 ACFt ACF (1 + k) t - IO Net Present Value Net • Decision Rule: • If NPV is positive, accept. If accept • If NPV is negative, reject. If reject NPV Example NPV Suppose we are considering a capital Suppose investment that costs $250,000 and $250,000 provides annual net cash flows of $100,000 for five years. The firm’s $100,000 required rate of return is 15%. 15% NPV Exa...
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