BF Ch. 9
NPV profile
a graph of a project's NPV over a range of discount rates
discounted payback period
Calculates the time it takes to get back invested capital in present value terms; Alleviates the problem of the regular payback period by incorporating The time value of money; Doesn't take into account payback after investment is recouped -discount each year's cash flow
The present value of the benefits and costs needed to calculate PI is the same information one finds when computing the NPV.
True
One of the underlying assumptions of the IRR model is that all cash inflows can be reinvested at the individual project's internal rate of return (IRR) over the remaining life of the project.
True
what are the shortcomings of the payback period model?
-biased towards projects with higher cash inflows for earlier years -fails to account for the time value of money
3 observations we can make about the capital budgeting decision
1. capital budgeting decision is typically a go or no-go decision on a product, service, or activity 2. a capital budgeting decision will require sound estimates of the time and amount of appropriate cash flow for the proposal 3. the capital budgeting model has a predetermined accept or reject criterion
hurdle rate
Minimum acceptable rate of return (set by management) for an investment.
profitability index
PI = NPV + cost / cost if PI > 1, accept the project; if PI < 1, reject the project
equivalent annual annuity
The level annual cash flow that has the same present value as the cash flows of a project. Used to evaluate alternative projects with different lives.
IRR
defined as the discount rate that produces a zero NPV or the specific discount rate at which the present value of the cost (the investment or cash outflows) equals the present value of the future benefits (cash inflows). The IRR rule prescribes that we should accept those investments in which the internal rate of return exceeds the required rate of return.
The most popular alternative to NPV for capital budgeting decisions is the ________ method.
internal rate of return
capital budgeting
long term decisions/investments
If we consider the terminal value of the cash inflow (their future values based on the company's cost of capital) we can then begin to find a ________ that gives the answer in terms of returns generally consistent with the dollar amounts of NPV.
modified internal rate of return (MIRR)
The ________ method is the one method that trumps all other capital budgeting methods.
net present value
payback period
the amount of time required for an investment to generate cash flows sufficient to recover its initial cost
crossover rate
the discount rate at which both projects have the same NPV
net present value
the present value of current and future benefits minus the present value of current and future costs
modified internal rate of return
underlying assumption that all cash flows are reinvested at the firm's cost of capital