Evaluation Tools Flashcards
Methods used to compare investments?
Payback, Net Present Value, Net Future Value, and Capitalized Equivalent
Difference between independent and mutually exclusive projects.
Independent- unrelated investment opportunities available
Mutually means choosing one project but rejecting other projects.
what is conventional payback period?
Length of time it takes to recover initial investment.
Disadvantages to payback rule?
- It ignores the time value of money
- Ignores project specific risk
- Cutoff point is arbitrary
- Ignores cash flows beyond the payback period
- Biased towards short term projects
Advantages of payback rule?
- Easy to use and understand
- Biased towards liquidity
- Adjusts for uncertainty of later cash flows…by completely ignoring them!
Discounted payback rule is?
• Considersthetimevalueofmoney
• Calculateandsumthepresentworthofeachoftheyearly
cashflows
• Thediscountedpaybackperiodisthenumberofyearsto
recovertheinvestmentfromthediscountedcashflows
what does NPV measure?
NPV is a measure of the value created or
lost.
What does MARR stand for and what is it?
Minimum Acceptable Rate of Return (lowest interest rate allowed by company)
It is the discount rate used in the calculation of NPV
When to accept a project based on NPV?
When NPV is greater than zero.
Reject when lower than zero
Remain indifferent when NPV is equal to zero.
When is the capitalized equivalent method used?
When project life is very long(>40 years) or project is perpetual.
What is Annual equivalent worth analysis used for?
Measure the worth of an investment.
Determines equal payments or earnings.
When is AE accepted?
when AE>0 accepted
AE<0 reject
AE=0 indifferent
Comparing mutually exclusive projects what are some restrictions
Compared in equal time spans
Analysis period must be taken to consideration.
What is capital recovery cost?
Whenaprojectisbeinganalyzed,andonlythecoststo
implementtheprojectarebeingconsidered
Costscanconsistofrecurringoperatingcostsandcapitalcostresulting from purchasing equipment
What is IRR?
internalrateofreturn(IRR)ofaninvestmentisthe
discountrateatwhichtheNPVofcosts(negativecash
flows)oftheinvestmentequalstheNPVofbenefits
(positivecashflows)oftheinvestment
also used to measure efficiency of investment.
Higher a projects IRR is?
The more desirable it is to undertake project.
a) IRR>MARR then?
b) IRR=MARR then?
c) IRR
a) accept
b) indifferent
c) reject
IRR vs NPV
IRR measures efficiency
NPV measures wealth
Advantages of IRR?
Easily understood
Widely used
Favours efficient investments
Disadvantages of IRR?
• Cannotcomparemutually exclusiveprojects • Requiresfuturecashflow estimates • Requiresidenticalproject durations • Mayproduce multiplevalues
Methods to calculate IRR?
– DirectSolution
– Trial‐and‐error
– Computersolution
What is direct solution method?
one inflow and outflow
Modified internal rate of return is?
method to address problems that arise with IRR by:
–AllnegativeandpositivecashflowsaregroupedinordertoeliminatethepossibilityofmultipleIRRs
AssumesallrevenuesarereinvestedattheMARR,ratherthantheIRRofaproject,whichpreventsoverestimationoftheIRR
What happens when equal project lives > analysis period
When alternatives have equal project lives but last longer than analysis period. In this case a salvage value is used
What happens when equal project lives < analysis period
Two options
- project is replaced with repeated identical projects until the end of the analysis period
- Leasing is used to cover the remainder of analysis period.
