Lecture 6 - NPV and Investment Decision Making Flashcards
1
Q
What is payback
A
How long the project takes to pay back its initial investment cost
2
Q
what is discounted payback
A
the same as payback, but recognises the time value of money
3
Q
strengths of payback and discounted payback
A
- easy to calculate
- intuitive
4
Q
weaknesses of payback
A
- PB ignores the time value of money
- accept and reject benchmarks are arbitrary
5
Q
what is Net Present Value (NPV)
A
measures value created by a project, so positive value indicates the project is desirable
6
Q
strengths of NPV
A
- not a ratio, it directly measures the expected increase in wealth from the project
- works for both independent and mutually exclusive projects
7
Q
weaknesses of NPV
A
- the discount rate used in NPV calculations is often debated
8
Q
what is IRR
A
- internal rate of return
- most popular technique
- it gives the same accept/reject decision for a single project as NPV when used with normal cash flow projects
9
Q
strengths of IRR
A
- no need for a discount rate
10
Q
weaknesses of IRR
A
- mutually exclusive projects
- multiple IRRs
- unrealistic reinvestment assumption
11
Q
what is MIRR
A
- modified internal rate of return
- fixes IRR reinvestment rate problem
- doesn’t fix mutually exclusive projects issue
12
Q
strengths of MIRR
A
- corrects IRRs reinvestment problem
13
Q
weaknesses of MIRR
A
- mutually exclusive projects
14
Q
what is PI
A
- profitability index
- based on NPV, used when firms has resource constraints on capital available for new projects
15
Q
Strengths of PI
A
- useful in conjunction with NPV
- when a company has limited funds, PI helps to prioritise projects
