FIN 331 Chapter 11

Conventional Cash Flows UnConventional Cash flows

-changes sign once -more than one sign change -Every change in sign we have a new IRR

Drawbacks of Payback Rule

Cumulative ignores time value of money and cash flows after payback

Drawbacks to Discounted Payback Rule

Takes into account TVM Still ignores cash flows after payback

The Internal Rate of Return

The discount rate that forces NPV of a project to equal 0 -only accept project if it exceeds cost of capital -Do not use IRR to compare projects because it may give you unsaul rates -does not have a realistic reinvestment rate

Net Present Value

The sum of the present values of a projects cash flows best tool to use Choose project with highest NPV

Net Present Value Profiles

graphical representation showing the relationship between a projects NPV and the firms cost of capital.

Discounted Payback Rule

same as payback except discounted (at the cost of capital) are used

Modified IRR (MIRR)

the discount rate at which the present value of a project's cost is equal to the present value of the terminal value, found by compounding the cash inflows at the cost of capital -gets rid of bad reinvestment rate assumption

Payback Rule

the expected number of years required to recover a projects cost