Understanding Flashcards
IRR of project gives useful information regarding…
….sensitivity of projects NPV to errors in estimate of its cost of capital
! difference between cost of capital and IRR is maximal estimation error that can exist without altering original decision!
The Payback rule and the NPV rule - which is more reliable?
NPV!
bc payback rule ignores projects cost of capital and time value of money and cash flows after the payback period
BUT payback rule really simple, especially in small investings
Applying the IRR Rule to mutually exclisuve projects is…
… not a good idea
because timing of CF, riskiness, scale of investment differs
Because the IRR is not itself a measure of value…
… it is easy to manipulate by restructuring the projects cash flows
Ultimate goal of capital budgeting?
determine the effect of the decision on the firms CFs, and evaluate the NPV of these CFs to assess the consequences of the decision of the firms value