FIN 401 Lecture Notes - Lecture 2: Net Present Value, Cash Flow, Decision Rule
Document Summary
Often strategic investments that define the business of a firm: some capital budgeting decision rules. Rule #2 - payback period: how long does it take to get the initial cost back in a nominal sense, calculation: Subtract the future cash flows from the initial cost until the initial investment has been recovered: two possibilities to assume: Cash flows occur at the end of the year. Cash flows occur evenly throughout the year: decision rule: accept if the payback period is less than some preset limit. Winter 2017: problems with the irr rule. The irr rule is problematic in the following two situations: When the cash flows change sign more than once, i. e. the cash flows are non- conventional. The irr and npv rules may lead to different decisions. Whenever there is a conflict between npv and another decision rule, you should always use the npv rule. Npv directly measures the increase in the firm value.
