Discounted Cash Flow Applications Flashcards
What is NPV?
the sum of the PVs of future cash flows, discounted at the cost of capital
What is NPV formula?
sigma(t=1, n) Ct x DFt - C0
C0 = cost of project
where Ct = is cash flow t
DFt = Discount Factor t
What is IRR?
The discount rate that makes NPV = 0
What is NPV rule?
Accept a project if NPV > 0
What is IRR rule?
Accept project is IRR > require rate of return
Compare NPV and IRR rules
Choose higher NPV is projects are mutually exclusive
For independent projects, NPV and IRR rules will yield same result
What problems are associated with IRR rule?
Assumes cash flows reinvested at same discount rate
What is Holding Period Return (HPR)?
Total return from a certain period. Change of value of investment (including income)
What is HPR formula?
HPR = (P1 - P0 - D1) / P0 = (P1 - D1)/P0 - 1
What is money-weighted return?
The IRR of a portfolio, taking into account all cash inflows and outflows
What is money-weighted return/yield?
The IRR of a portfolio, taking into account all cash inflows and outflows
What is bank discount yield?
Quoting approach based on discount basis. Usually used for US T-Bills. rate is annualized
r = (D/F) x (360/t)
D = discount amount (face value - purchase price) F = face value or par value t = days remaining until maturity 360 = bank convention days in a year
What is effective annual yield?
An annualized yield based on 365 day year, and takes into account the compounding of interest
What is effective annual yield?
An annualized yield based on 365 day year, and takes into account the compounding of interest
EAY = (1 + HPY)^(365/t) - 1
What is money market yield?
MMY or CD equivalent yield using 360 day year
r = HPY x (360/t)
