Lecture 8: More cashflow (NPV)

Question 1

When is payback time reached?

Answer 1

how long to make back initial investment? =? When cumulative cashflow switches to positive

Question 2

Define present value of money

Answer 2

We define the present value of A as the amount of money B that, if we were to invest it now in an interest-bearing account at X%, would be equal to A in n=5 years

Question 3

Define NPV

Answer 3

Sum of discounted cashflows => includes initial investment
• Compares projects predicted outcome to ‘standard of growth’ represented by X% => NPV difference between what we estimate project will make and what initial investment would make (invest year 0 at X% interest)
- If NPV(X) is positive, the project’s estimated net profit is greater than what would be gained by investing the capital at X% (ie in a bank account paying X%)
- If NPV(X) is exactly zero, the estimated net profit equals what would be gained by investing the capital at X%
If NPV(X) is negative, the estimated net profit is less than what would be gained by investing the capital at X%

Question 4

How do you decide X?

Answer 4

· Minimum value should be safest lowest risk investment i.e. bank interest rate
· Business often demand higher X i.e. continue project promising better growth
Why? - estimates could be wrong => more risk,