16 13 comparing the npv and irr methods methods the

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Unformatted text preview: pital. 16-13 Comparing the NPV and IRR Methods Methods The net present value The net present value method has the following method has the following advantages over the advantages over the iinternal rate of return nternal rate of return method .. .. .. method Easier to use. Easier to use. Easier to adjust for risk. Easier to adjust for risk. 16-14 Assumptions Underlying Discounted-Cash-Flow Analysis Discounted-Cash-Flow All cash flows are treated as though they occur at year end. Cash flows are Cash treated as if treated they are known with certainty. Assumes a perfect capital market. Cash inflows are immediately reinvested at the required rate of return. 16-15 Choosing the Hurdle Rate Choosing • The discount rate generally is associated with the company’s cost of capital. • The cost of capital involves a blending of the costs of all sources of investment funds, both debt and equity. 16-16 Comparing Two Investment Projects Projects To compare competing investment projects we can use the following net present value approaches: – Total-Cost Approach. – Incremental-Cost Approach. 16-17 Total-Cost Approach Total-Cost • Each system would last five years. • 12 percent hurdle rate for the analysis. MAINFRAME PC _ Salvage value old system $ 25,000 $ 25,000 Cost of new system (400,000) (300,000) Cost of new software ( 40,000) ( 75,000) Update new system ( 40,000) ( 60,000) Salvage value new system 50,000 30,000 ================================================ Operating costs over 5-year life: Personnel (300,000) (220,000) Maintenance ( 25,000) ( 10,000) Other costs ( 10,000) ( 5,000) Datalink services ( 20,000) ( 20,000) Revenue from time-share 25,000 - 16-18 Total-Cost Approach Total-Cost MAINFRAME ($) Acquisition cost computer Acquisition cost software System update Salvage value Operating costs Time sharing revenue Total cash flow X Discount factor Present value Today (400,000) ( 40,000) Year 1 Year 2 Year 3 Year 4 Year 5 ( 40,000) (335,000) 20,000 440,000 X 1.000 (440,000) 50,000 (335,000) (335,000) (335,000) (335,000) (335,000) 20,000 20,000 20,000 20,000 20,000 (315,000) (315,000) (355,000) (315,000) (265,000...
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This note was uploaded on 02/10/2014 for the course ACCT 331 taught by Professor Kline during the Fall '10 term at Drexel.

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