Investment Decision (2) Flashcards
What does NPV method compare?
The PV of all cash inflows from a project with the PV of all cash outflows from a project
When NPV is positive?
Return from investment’s cash inflows in excess of cost of capital
When NPV is negative?
Return from investment’s cash inflows below cost of capital
When NPV is 0?
Return from ivnestment’s cash inflows same as cost of capital
Advantage of NPV?
It gives a clear and objective decision rule for accepting and rejecting projects
What is IRR
Calculates the exact return which a project is expected to achieve. When NPV = 0
What happens when IRR is greater than required return (cost of capital)
Undertake proejct
What happens when IRR is less than required return (cost of capital)
Don’t udnertake project
What happens when IRR = required return (cost of capital)
Udnertake project
NPV and IRR similarities
DCF methods
Relevant cash flows
Look at cash flows over whole life of project (unlike payback)
When IRR > NPV
Gives percentage return, making for easy comparison
When NPV > IRR
Comparing projects of different sizes
Non-convential cash flows
Re-investment assumption
Why is IRR bad at comparing projects of different sizes?
Leads to incorrect choices as % is bad at gaging the size
Issue with IRR and cash flows?
Non-convential cash flows are included, therefore multiple IRRS sometimes occur
IRR and reinvestment?
IRR overstimates the project’s annual return, as it assumes cash flows can be reinvested elsewhere to earn a return equal to IRR of original project
