Unformatted text preview: 9 Net Present Value and Other
Investment 1 Key Concepts and Skills
Be able to compute payback and discounted
payback and understand their shortcomings
payback Understand accounting rates of return and their
shortcomings Be able to compute the internal rate of return and
understand its strengths and weaknesses
understand Be able to compute the net present value and
understand why it is the best decision criterion
understand 2 Chapter Outline Net Present Value The Payback Rule The Discounted Payback The Average Accounting Return The Internal Rate of Return The Profitability Index The Practice of Capital Budgeting
3 Good Decision Criteria We need to ask ourselves the following
We questions when evaluating capital
budgeting decision rules
budgeting Does the decision rule adjust for the time
value of money?
Does the decision rule adjust for risk?
Does the decision rule provide information on
whether we are creating value for the firm?
whether 4 Project Example Information You are looking at a new project and you have
estimated the following cash flows:
estimated Year 0: CF = -165,000
Year 1: CF = 63,120; NI = 13,620
Year 2: CF = 70,800; NI = 3,300
Year 3: CF = 91,080; NI = 29,100
Average Book Value = 72,000 Your required return for assets of this risk is
5 Net Present Value The difference between the market value of a
project and its cost
How much value is created from undertaking an
investment? The first step is to estimate the expected future cash
The second step is to estimate the required return for
projects of this risk level.
The third step is to find the present value of the cash
flows and subtract the initial investment.
flows 6 NPV – Decision Rule If the NPV is positive, accept the project
A positive NPV means that the project is
expected to add value to the firm and will
therefore increase the wealth of the owners.
Since our goal is to increase owner weal...
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- Spring '14
- Net Present Value, Internal rate of return