Lecture 3 Flashcards
Accounting rate of return (ARR)
ARR = Average annual operating profit / average investment x 100
Higher ARR is ….
Better
Main problem with ARR
Ignores time factor
What is payback period
Length of time it takes for a project to repay its initial investment
Shorter payback period is …
Better
When is the end of the payback period
When the total net cash flow becomes positive
Problems with pp
Timing of cash flow not fully considered
What is NPV
Calculates the monetary value now of a project’s future cash flow
How to find the PV
Cash flow x Discount Factor
How to find NPV
Add together all the PVs (Present values of future cash flows)
And subtract the initial cash flow
How to calculate NPV
Cash flow / (1.(discount rate)) to the power of how many years
If the NPV is negative, the project should be
Rejected
The higher the NPV the …
Better
What is the Internal Rate or Return (IRR)
The discount rate, which, when applied to the future cash flows of a project, will produce an NPV of precisely 0
How to find PP
Final year before 0
Cumulative cash flow / the next years net cashflow
