FIN MGMT Chapter 9

An investment is acceptable if the IRR exceeds the required return. It should be rejected otherwise.

IRR RULE

average net income

Sum of the net incomes for n year / n

if a project has a __________ NPV, then the present value of the future cash flows must be bigger than the initial investment.

positive

Cross-over rate

the rate at which two projects have the same NPV's

The point in which NPV crosses the vertical axis

the sum of cash flows of the project

Net Present Value (NPV)

the sum of the present values of expected future cash flows from an investment, minus the cost of that investment. NPV = PV - investment cost

According to the average accounting return rule, a project is acceptable if its average accounting return exceeds:

a target average accounting return

The average accounting return is:

average net income/book value

Conventional Cash Flows

cash flow (initial investment) starts in the negative

The point in which NPV crosses the horizontal axis

internal rate of return (IRR)

IRR approach will lead to incorrect decisions on ______________ exclusive projects

mutually

Discounted Payback Period steps:

1. discount the cash flows using discount rate 2. add the discounted cash flows 3. accept if the discounted payback period is less than the predetermined set of time

Average Book Value

700,000+0 / 2 (ALWAYS HALF)

NPV Investment Rule

Accept if above zero Reject if below zero Accept or reject if equal to zero

How does the timing and size affect cash-flows in payback method?

An increase in the size of the first cash flow will decrease payback period, all else held constant.

NPV ____ cash flows properly

Discounts

The amount by which the value a firm will change if a project is accepted

NPV

By ignoring time value, the payback period can accept a ______________ NPV. (positive/negative)

Negative

In Capital Budgeting, the ____ ____________ ___________ determines the value of a project to a company.

Net Present Value

This capital budgeting method allows lower management to make smaller, everyday financial decisions effectively.

Payback Method

Profitability Index (PI)

The present value of an investment's future cash flows divided by its initial cost. Also called the benefit-cost ratio. PV/initial investment

If the IRR is greater than the ______ ________, we should accept the project.

required return

Present Value (PV)

the current value of future cash flows discounted at the appropriate discount rate. PV = $1[1/(1+r)^n]

The IRR on an investment is the required return that results in a zero NPV when it is used as the discount rate.

IRR RULE