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