Accounting return there are many different

Info iconThis preview shows page 1. Sign up to view the full content.

View Full Document Right Arrow Icon
This is the end of the preview. Sign up to access the rest of the document.

Unformatted text preview: e / average book value Note that the average book value depends on how Note the asset is depreciated. the Need to have a target cutoff rate Decision Rule: Accept the project if the AAR Decision is greater than a preset rate. is 19 19 Computing AAR for the Project Assume we require an average accounting Assume return of 25% return Average Net Income: (13,620 + 3,300 + 29,100) / 3 = 15,340 AAR = 15,340 / 72,000 = .213 = 21.3% Do we accept or reject the project? 20 20 Decision Criteria Test - AAR Does the AAR rule account for the time value of Does money? money? Does the AAR rule account for the risk of the Does cash flows? cash Does the AAR rule provide an indication about Does the increase in value? the Should we consider the AAR rule for our primary Should decision rule? decision 21 21 Advantages and Disadvantages Advantages of AAR of Advantages Easy to calculate Needed information Needed will usually be available available Disadvantages Not a true rate of Not return; time value of money is ignored money Uses an arbitrary Uses benchmark cutoff rate benchmark Based on accounting Based net income and book values, not cash flows and market values and 22 22 Internal Rate of Return This is the most important alternative to This NPV NPV It is often used in practice and is intuitively It appealing appealing It is based entirely on the estimated cash It flows and is independent of interest rates found elsewhere found 23 23 IRR – Definition and Decision IRR Rule Rule Definition: IRR is the return that makes the Definition: NPV = 0 NPV Decision Rule: Accept the project if the IRR Decision is greater than the required return is 24 24 Computing IRR for the Project If you do not have a financial calculator, then this If becomes a trial and error process becomes Calculator Enter the cash flows as you did with NPV Press IRR and then CPT IRR = 16.13% > 12% required return Do we accept or reject the project? 25 25 NPV Profile for the Project 70,000 IRR = 16.13% 60,000 50,000 NPV 40,000 30,000 20,000 10,000 0 -10,000 0 0.02 0.04 0.06 0.08 0.1 0.12 0.14...
View Full Document

This document was uploaded on 03/01/2014 for the course FINANCE 250 at Indiana.

Ask a homework question - tutors are online