Chapter 8 - Net present value and other investment criteria

Question 1

net present value

Answer 1

the difference between an investment’s market value and its cost

Question 2

discounted cash flow (DCF) valuation

Answer 2

• calculating the present of a future cash flow to determine its value today
• the process of valuing an investment by discounting its future cash flows

Question 3

payback

Answer 3

the length of time it takes to recover our initial investment

Question 4

payback period

Answer 4

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

Question 5

what is the biggest drawback of the payback period

Answer 5

doesn’t ask the right question
- the relevant issue is the impact an investment will have on the value of our stock, not how ling it takes to recover the initial investment

Question 6

advantages of the payback period rule

Answer 6

• easy to understand
• adjusts for uncertainty of later cash flows
• biased toward liquidity