Net Present Value & investment criteria Flashcards
What is the Net present value?
the difference between an investment’s market value and its cost
What is Discounted Cash Flow Valuation?
The process of valuing an investment by discounting its future cash flows
What are the strengths of using the NPV?
it uses cash flows
uses all cash flows
discounts cash flows
gives the value created for shareholder by a project
Payback is…? and when should you accept a project?
The amount of time required for an investment to generate cash flows sufficient to recover its initial cost.
accept project with shortest payback
What are the advantages and disadvantages of the payback period rule?
:) easy to understand
:) adjusts for uncertainty
:) biased towards liquidity
> ignores time value of money
requires arbitrary cut-off point
ignores cash flows beyond cut-off date
biased against long-term projects such as R&D
What is discounted payback?
The length of time required for an investment’ discounted cash flows to equal its initial cost
What are the advantages and disadvantages of discounted payback?
:) INCLUDES time value of money
:) easy to understand
:) does not accept negative estimated NPV investments
:) biased towards liquidity
> may reject positive NPV investments
requires an arbitrary cut-off point
ignores cash flows beyond cut off date
biased against long term projects
what is AAR (average accounting return)?
An investment’s average net income divided by its average book value
What is the Internal Rate of Return?
The discount rate that makes the NPV of an investment zero.
What is the Profitability Index?
the present value of an investment’s future cash flows divided by its initial cost.
