Chapter 12 Flashcards
what are measures to evaluate capital budget projects
NPV, IRR, MIRR
what is NPV
sum of all PV’s of all CFs or net gain in wealth
it is direct measure of dollar benefit
what does a projects NPV have to be to accept it
positive
what is NPV dependent on
the cost of capital
what is the IRR
the discount rate that forces PV inflows to equal cash and your NPV to equal 0
What does IRR measure
how much rate of return a project will give you
If IRR > r, then…
the projects return is greater than its costs
what is the reason IRR and NPV might not give us the same decision
non-normal cash flows
mutually exclusive projects
what are normal cash flows
cash flow signs start negative then are followed by a positive
what are non normal cash flows
two or more of the cash flows change from positive or negative
what are mutually exclusive projects
if you choose one you can’t choose the other
what are independent projects
two projects that are not mutally exclusive
what is the crossover point
the point where two mutually exclusive projects have the same r and NPV
what are two reasons NPV profiles cross
- size difference of CF
- timing difference of CF
is NPV always the most important
yes
when is IRR unreliable
where there is non conventional cash flows and when projects are mutually exclusive
What is MIIR
the modified internal rate of return is the discount rate that causes the PV of costs to grow to a project terminal value
also avoids multiple rate of return problem
what is the terminal value
FV of cash inflows
what does MIRR assume
that cash flows are reinvested at WAAC
Is MIRR or IRR better?
MIRR because it correctly assumes reinvestment at opportunity cost and gives managers a better rate of return comparison
what is the profitibility index?
the present value of future cash flows divided by the initial cost
what does a profitability of 1.1 suggest
that for every $1 of investment, an additional 10 cents of value is created
what is the payback period
the number of years that is required to recover a projects cost
“how long it takes to get money back”
what are strengths of payback
- provide an indication of the risk and liquidity of a project
- easy to calculate and understand
what are weaknesses of payback
- ignore the TVM
- ignores CF’s occurring after the payback period
- No specification of acceptable payback
what does PI measure
profitability relative to the cost of the project
- shows project risk
what does payback measure
risk and liquidity
what do discounted paybacks use
discounted CFs
