COMM 308 Study Guide - Midterm Guide: Normal Distribution, Risk Premium, Market Trend
20 Nov 2016
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Discount rate to be used when analyzing an investment project is: rate of of return which financial markets offer on investments of similar risk. To accept a project, npv >0 or profitability index (pi) has to be >1 and irr has to be more than the cost of capital or discount rate (k). With capital rationing, pi would be better because it measures the % return per $ invested. In all other situations, npv would be better because it measures the total wealth change. A project where npv = 0 is expected to earn a return equal to firm"s required return. Pi >1 when irr is > than discount rate. Can be ambiguous for large differences in cfs. Npv = pv cash inflows pv cash outflows. Assumes cfs are reinvested at discount rate: pv of cash inflows = npv + cash outflows. Irr is rate which makes npv of project = 0 and pi = 1.
