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Chapter 7

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Wilfrid Laurier University
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BU383 Chapter 7 – Net Present Value and Other Investment Rules Week 1 Why Use Net Present Value? -Accept a project if the NPV is greater than zero and vice versa -The NPV rule leads to good decisions -Accepting positive NPV projects benefits the shareholders -The value of the firm rises by the NPV of the project -The value of the firm is merely the sum of the values of the different projects, divisions, or other entities within the firm – value additivity -The contribution of any project to a firm’s value is simply the NPV of the project -The discount rate on a risky project is the return that one can expect to earn on a financial asset of comparable risk -The discount rate is often referred to as the opportunity cost -NPV uses cash flows -NPV uses all the cash flows of the project -NPV discounts the cash flows properly The Payback Period Rule -A minus sign in front of a number indicates a cash outflow -A cut-off time, say two years is selected – all investment projects that have payback periods of two years or less are accepted and all of those that pay off in more than two years, if at all, are rejected -Problems with the payback period method: -Timing of cash flows within the payback period -Payments after the payback period -Arbitrary standard for payback period -The payback period is acceptab
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