Chap016

# The 16 30 ranking investment projects ranking lets

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Unformatted text preview: cts Ranking Let’s calculate the present value of the cash flows associated with Project A. This project has a positive net present value which means This project has a positive net present value which means This This the project’s return is greater than the discount rate. tthe project’s return is greater than the discount rate. the he 16-31 Ranking Investment Projects Ranking Here is the net present value of the cash flows associated with Project B. Immediate cash outlay Cash inflows: Year 1 Year 2 Year 3 Net present value Project B \$(100,000) \$ 30,000 40,000 50,000 PV Factor 1.000 PV \$(100,000) 0.909 0.826 0.751 27,270 33,040 37,550 \$ (2,140) Project B has a negative net present value which means Project B has a negative net present value which means Project the project’s return is less than the discount rate. tthe project’s return is less than the discount rate. the he 16-32 Alternative Methods for Making Investment Decisions Investment Payback Method Payback Initial investment = period Annual after-tax cash inflow Annual A company can purchase a machine for \$20,000 that A company can purchase a machine for \$20,000 that will provide annual cash inflows of \$4,000 for 7 years. will provide annual cash inflows of \$4,000 for 7 years. Payback = period \$20,000 \$4,000 \$4,000 = 5 years 16-33 Payback: Pro and Con Payback: 1. Fails to consider 1. Fails to consider tthe time value of he time value of money. money. 2. Does not consider 2. Does not consider a project’s cash a project’s cash fflows beyond the lows beyond the payback period. payback period. 1. Provides a tool for roughly screening investments. 2. For some firms, it may be essential that an investment recoup its initial cash outflows as quickly as possible. 16-34 Accounting-Rate-of-Return Method Method Discounted-cash-flow method focuses on cash flows and the time value of money. Accounting-rate-of-return method focuses on the incremental accounting income that results from a project. 16-35 Accounting-Rate-of-Return...
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