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Unformatted text preview: 5. The appropriate discount
rate is 10%.
• Answer: The NPV is $2.313m, which is greater
than 0. The project should be approved. 9-10 NPV Example #3
• Calculate the NPV if the project cost is $30,000 and the future
benefits are $6,000 per year for 8 years. Use a discount rate
• Note that in this problem the cash flows are even. You can
use the annuity function in your calculator.
• The present value of the future cash flows is calculated using
• N=8, I=15, PMT=6000, FV=0, P/YR=1
• CPT PV 26,924 aka benefits
• This is not the NPV because it doesn’t take into account the
costs at time 0. The costs at time 0 are 30,000.
• NPV = 26,924 – 30,000 = - 3,076
• Reject the project since NPV<0. 9-11 Note regarding upfront costs
• Ultimately we are trying to decide whether the
present value of the future benefits outweighs the
• Keeping track of the direction of cash flows (and
the positive or negative sign) is critical
• Also be sure that the time 0 cash flows are
• Depending on how you perform the calculation, you
may be able to do just one calculation that includes
the large negative cost amount at time 0. But in other
circumstances, you would do the present value of the
future benefits in one step and then subtract the costs
in a second step.
9-12 Decision Criteria Test - NPV
• Does the NPV rule account for the time
value of money?
• Yes, it does! • Does the NPV rule account for the risk of
the cash flows?
• Yes, it does, through the interest rate used! • Does the NPV rule provide an indication
about the increase in value?
• Yes, it does! The NPV figure itself tells us how
much value will be created.
9-13 Payback Period 9.2
• Second tool available to financial managers to
determine whether or not to proceed with the
• This method evaluates how long it would take to
get the initial cost back. There is no time-valueof-money calculation
• Estimate the cash flows
• Determine how long it takes for the future cash flows
to add up to the origi...
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This document was uploaded on 02/06/2014.
- Fall '14