AMA Q22 - Chapter 12 Flashcards
What is PP
Payback Period
The time it takes an investment’s cash inflows to exceed the initial cost
What are the two criteria when deciding whether to accept a project in regards to PP?
- Is the PP within the company policy?
- Is the PP the shortest of all options?
Advantages of PP
- Easy to understand
- Considers liquidity/cash-flow
- Quick calculation
Disadvantages of PP
- Arbitrary
- Ignores the value of money
- Ignores the specific timing of the cash inflows
What is DPP?
Discounted Payback Period
Almost the same as Payback Period
Three reasons for the time-value of money
- Risk - having the money is seemed as more risky than someone promising it
- Consumption - Being able to spend the money is useful
- Investment - money can be invested
How to calculate the discount factor
1/ compound interest to the power of how every long (years)
Present value calculation
Future amount x 1/compound interest to the power of how every long (years)
NPV calculation
Total of all inflows at discounted rate less initial investment amount
Cost of capital?
The interest that could be earned on an amount of money
When should a project be rejected in regards to NPV?
if the value is negative, or the highest value
(it means the return is less than just earning interest on the money)
Discount rate = cost of capital
Discount rate = cost of capital
Disadvantage of discounted cashflow technique, NPV?
It doesn’t factor the risk of the investment
Advantage of discounted cashflow technique, NPV?
It accounts for the time value of money
Net present costs
the cost of a piece of ongoing expenditure at its discounted value
