25300 Lecture Notes - Lecture 7: Payback Period, Cash Flow, Net Present Value
All investment have costs
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All investment should have benefits
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Costs and benefits are measured in terms of cash flow
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Generation of proposals
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Evaluation and selection of capital projects
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Approval and implementation
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Monitoring continuously
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Process:
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Investment decision
Is the difference between the present value of future cash flows and the cost of the investment
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r: the required rate of return
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CFt: the cash flow for time period t
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NPV is the change in shareholders' wealth
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Accept all projects when NPV > 0
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Net Present Value
The rate of return based on a project's cash flows
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IRR is the required rate of return that gives a zero NPV
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Accept projects when IRR > required rate of return
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You will not be asked to calculate IRR in exams
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Internal Rate of Return
Simplest, the most frequently used methods
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Is the length of time required for the investment's stream of cash flows to equal the initial cost
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Is determined by adding expected cash flows for each year until the total is equal to original outlay
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Accept the project if payback period < the specified payback period
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Income beyond payback date is ignored
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Payback period for uneven cash flows:
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Payback period
Lec 7 Capital Budgeting 1
F Page 16
Document Summary
Costs and benefits are measured in terms of cash flow. Is the difference between the present value of future cash flows and the cost of the investment. Net present value r: the required rate of return. Cft: the cash flow for time period t. The rate of return based on a project"s cash flows. Irr is the required rate of return that gives a zero npv. Accept projects when irr > required rate of return. You will not be asked to calculate irr in exams. Is the length of time required for the investment"s stream of cash flows to equal the initial cost. Is determined by adding expected cash flows for each year until the total is equal to original outlay. Accept the project if payback period < the specified payback period. Provides an insight into risk (shorter payback -> less risky) Fails to five any consideration to cash flows after payback. Remove the problems with normal payback calculation (tvm)
