Net Present Value and other investment criteria

Question 1

net present value (NPV)

Answer 1

The difference between an investment’s market value and its cost.

Question 2

discounted cash flow (DCF) valuation

Answer 2

The process of valuing an investment by discounting its future cash flows.

Question 3

payback period

Answer 3

The amount of time required for an investment to generate cash flows sufficient to recover its initial cost.

Question 4

discounted payback period

Answer 4

The length of time required for an investment’s discounted cash flows to equal its initial cost.

Question 5

average accounting return (AAR)

Answer 5

An investment’s average net income divided by its average book value.

Question 6

internal rate of return

Answer 6

The discount rate that makes the NPV of an investment zero.

Question 7

net present value profile.

Answer 7

A graphical representation of the relationship between an investment’s NPVs and various discount rates.

Question 8

multiple rates of return

Answer 8

The possibility that more than one discount rate will make the NPV of an investment zero.

Question 9

mutually exclusive investment decisions.

Answer 9

A situation in which taking one investment prevents the taking of another.

Question 10

profitability index

Answer 10

The present value of an investment’s future cash flows divided by its initial cost. Also called the benefit–cost ratio.