Investment Decision

-100

40

40

40

SHOULD WE PURSUE THIS INVESTMENT?

WHAT WOULD YOU CONSIDER?

Average Accounting Return

-100

40

40

40

= 0.53 or 53%

Measure of accounting profit relative to book value.

Similar to return on assets measure.
Take the investment if the AAR exceeds some specified return level.

Payback Period Rule

-100

40

40

40

Length of time until initial investment is recovered

Take the project if it pays back in some specified period

Discounted Payback Period Rule

-100

40

40

40

Assume interest rate

Of 8%
$37.04

$34.29

$31.75

Length of time until initial investment is recovered on a discounted ba

Take the project if it pays back in some specified period

LO1

Net Present Value (NPV)

The difference between the market value of a project
and its cost
How much value is created from undertaking an
investment?
The first step is to estimate the expected future cash
flows.
The second step is to estimate the required return for
projects of this risk level.
The third step is to find the present value of the cash
flows and subtract the initial investment.

Net Present Value (NPV)

-100

40

An investment in this
Industry should return
5%

$38.09

40

$36.28

40

$34.55

$108.92
NPV = initial investment + PV of future cash flows
NPV

= -100 + 108.92
= $8.92

Profitability Index

-100

40

$38.09

40

$36.28

40

$34.55

$108.92

Take investment if PI >

Internal Rate of Return (IRR)

-100

40

40

IRR = 9.7%
Take the project if the IRR is
greater than required return

40

Internal Rate of Return (IRR)

-100

40

$36.46

40

$33.24

40

$30.30

$100
Note: the IRR is the discount rate that makes NPV = 0
0 = Initial Investment + PV of Future Cash Flows
0 = -100 + 100