Finance Chapter 9

The discounted payback period of a project will decrease whenever the

Amount of cash inflows is increased

The discounted payback rule may cause

some positive net present value projects to be rejected.

Payback Period

the amount of time required for an investment to generate cash flows sufficient to recover its initial cost

Net Present Value (NPV)

the difference between an investment's market value and its cost Pv of cash inflows less Pv of cash outflows Estimate the req return for projects

Discounted Payback Period

the length of time required for an investment's discounted cash flows to equal its initial cost

Profitability Index

the present value of an investment's future cash flows divided by its initial cost

discounted cash flow (DCF) valuation

the process of valuing an investment by discounting its future cash flows

A project has a required payback period of three years. In this case the

Cash flow in year two is valued just as highly as the cash flow in year one

All else equal, the payback period for a project will decrease whenever the

Cash inflows are adjusted such that they occur sooner

Crossover

Compute irr

The advantages of the payback method of project analysis include the

Bias toward liquidity Ease of use (2 and 3)

What increases the net present value of a project

Decreasing the required rate of return

Capital Budgeting Decision

Have long term effects on a firm

The internal rate of return

Ignored the initial investment in a project Is the rate that causes the net present value of a project to equal zero (2&3)

The reason internal rate of return method of analysis is bad

Is because it may lead to incorrect decisions when comparing mutually exclusive projects

When net present value is positive

It creates value for a firms owners

Discounted payback is used less frequently than payback because

It included time value of money calculations

According to the payback rule a project is acceptable when the payback period is

Less than the pre-specified period

profitability index is closely related to

NPV

A project is accepted when

NPV>0, is positive

Assuming that straight line depreciation is used, the average accounting return for a project is computed as the average

Net income of a project divided by the average instrument in a project

The Irr tends to be

One of the two most frequently used methods of project analysis

The final decision on which project to use is based upon

Required rate of return

Payback is frequently used to analyze independent projects because:

The cost of an analysis is less than the potential loft from a faulty decision

Internal Rate if Return (IRR)

The discount rate that makes the net present value of an investment exactly equal to zero

Net present value is

The preferred method of analyzing a project even though the cash flows are only estimates And should be used when deciding between mutually exclusive projects

Irr will increase if

The salvage value of the assets utilized by the project is increased

Elements of IRR analysis

The timing of cash flows The rate designated as the minimum acceptable rate of return for a project The amt of each cash flow (1,3,4)

Reviewing a project from a cost benefit perspective

Use the profitability index

Accept profitability index

When greater than >1

Mutually exclusive investment decision

a situation in which taking one investment prevents the taking of another Always base decision off of NPV

If a project has a net present value equal to zero, then:

any delay in receiving the projected cash inflows will cause the project's NPV to be negative.

What is an example of a capital budgeting decision

deciding whether or not to a new product should be produced