10 views

Uploaded by hayward2sac

lecture slides

save

- Conch Case
- Finance Week 6
- Capital
- Model Africa
- LCC Analize
- Irr
- Victoria Chemicals Part 1
- Calculate IRR in Excel
- Methods criteria
- Ccim Financial Calculator v 6 1
- Super-I
- 20170404162102new_heritage_dolls_fact_sheet.docx
- AU FINC 501 MidTerm Exam 2nd Semester2015ss V2
- Chapter 6 Slides
- Sample on Financial Analysis from Instant Assignment
- Cram Sheet
- FIN 575 TUTOR Learn by Doing / fin575tutor.com
- MKL - Primus - Copy
- AC 3 - Aurora Textile Company (1)
- MIT11_202F10_rec2
- Capital Budgeting Practices- A Survey of Central and Eastern European Firms
- ch26
- ADM 2350N Quiz 2 V1 Winter 2010
- 733-1521-1-PB
- Sugar Mill in Bolivia - Financial Feasibility 2010
- Contoh Format Tk21 Revised Assignment5
- Session 3
- Modelo de Plan de Acción
- Broiler Fs
- invretB.pdf
- Cost of Capital_ Chapter 10
- Fall 2001 closed stat test
- Fall 2005 closed book stat test
- fall 2004 closed stat test
- Bonds and Bond Valuation_chapter 5
- Fall 2004 closed book stat test
- Capital Structure_chapter 16
- Fall 2001 closed stat test
- Biostat6651_Lecture4
- Biostat6651_Lecture3_rev1
- Time Value of Money_chapter 2
- Ethanol Madness
- Acct 3230 Project One
- Biostat6651_Lecture2
- Chapters 3 12 Financial Statements Cash Flow Estimation (1)

You are on page 1of 27

California State University-East Bay

2-1

**Good Decision Criteria
**

• We need to ask ourselves the following questions when evaluating decision criteria

1. Does the decision rule adjust for the time value of money? 2. Does the decision rule adjust for risk? 3. Does the decision rule provide information on whether we are creating value for the firm?

California State University-East Bay

2-2

The third step is to find the present value of the cash flows and subtract the initial investment. 3.Net Present Value • The difference between the market value of a project and its cost • How much value is created from undertaking an investment? 1. Estimate the expected future cash flows. Estimate the required return for projects of this risk level. California State University-East Bay 2-3 . 2.

Net Present Value 0 1 2 3 4 5 |----------|----------|----------|----------|----------| -250 -100 -100 -100 -100 -100 +200 +200 +200 +200 +200 +100 +100 +100 +100 +100 If conventional CFs. 0 1 2 3 4 5 |----------|----------|----------|----------|----------| (-) (+) (+) (+) (+) (+) California State University-East Bay 2-4 .

Net Present Value Cn C1 C2 NPV C0 2 n 1 r 1 r 1 r California State University-East Bay 2-5 .

NPV is a direct measure of how well this project will meet our goal. California State University-East Bay 2-6 . accept the project • A positive NPV means that the project is expected to add value to the firm and will therefore increase the wealth of the owners.NPV – Decision Rule • If the NPV is positive. • Since our goal is to increase owner wealth.

California State University-East Bay 2-7 .080 • Your required return for assets of this risk is 12%.000 CF = 63.120 CF = 70.800 CF = 91.Project Example Information • You are looking at a new project and you have estimated the following cash flows: Year 0: Year 1: Year 2: Year 3: CF = -165.

12)3 – 165.627.Computing NPV for the Project • Using the formulas: NPV = 63.080/(1.800/(1.42 • Do we accept or reject the project? California State University-East Bay 2-8 .120/(1.12) + 70.12)2 + 91.000 = 12.

2nd [CLR WORK] CF0 = -165.080 ENTER NPV.Computing NPV for the Project • Using the calculator: CF.800 ENTER F02 = 1 C03 = 91. I = 12 ENTER CPT => 12.41 California State University-East Bay 2-9 .120 ENTER F01 = 1 C02 = 70.627.000 ENTER C01 = 63.

California State University-East Bay 2 .10 .NPV • Does the NPV rule account for the time value of money? • Does the NPV rule account for the risk of the cash flows? • Does the NPV rule provide an indication about the increase in value? • NPV rule is our primary decision.Decision Criteria Test .

11 .IRR – Definition and Decision Rule • Definition: the return that makes the NPV = 0 Cn C1 C2 NPV 0 C0 2 n 1 IRR 1 IRR 1 IRR • Decision Rule: Accept the project if the IRR is greater than the required return California State University-East Bay 2 .

Computing IRR For The Project • This is a trial and error process • Calculator CF.12 .000 ENTER C01 = 63.13 • Do we accept or reject the project? California State University-East Bay 2 . 2nd [CLR WORK] CF0 = -165.800 ENTER F02 = 1 C03 = 91.080 ENTER IRRCPT => 16.120 ENTER F01 = 1 C02 = 70.

16 0.NPV Profile For The Project 70.04 0.1 0.000 60.2 0.000 10.13% NPV 30.18 0.14 0.000 40.000 20.000 0 -20.000 Discount Rate 0.000 IRR = 16.12 0.08 0.000 0 -10.06 0.22 California State University-East Bay 13 .000 50.02 0.

Decision Criteria Test .IRR • Does the IRR rule account for the time value of money? • Does the IRR rule account for the risk of the cash flows? • Does the IRR rule provide an indication about the increase in value? • Should we consider the IRR rule for our primary decision criteria? California State University-East Bay 2 .14 .

Advantages of IRR • Knowing a return is intuitively appealing (This is why it is often used in practice) • It is a simple way to communicate the value of a project to someone who doesn’t know all the estimation details • It is based entirely on the estimated cash flows and is independent of interest rates found elsewhere • If the IRR is high enough.15 . which is often a difficult task California State University-East Bay 2 . you may not need to estimate a required return.

NPV Vs. IRR • NPV and IRR will generally give us the same decision • Exceptions Non-conventional cash flows – cash flow signs change more than once Mutually exclusive projects • Initial investments are substantially different • Timing of cash flows is substantially different California State University-East Bay 2 .16 .

IRR and Non-conventional Cash Flows • When the cash flows change sign more than once. there could be more than one IRR • When you solve for IRR you are solving for the root of an equation and when you cross the x-axis more than once.17 University-East Bay . which one California doState you use to make your decision? 2 . there will be more than one return that solves the equation • If you have more than one IRR.

IRR – Definition and Decision Rule • Definition: the return that makes the NPV = 0 Cn C1 C2 NPV 0 C0 2 n 1 IRR 1 IRR 1 IRR California State University-East Bay 2 .18 .

0 1 2 3 4 5 |----------|----------|----------|----------|----------| (-) (+) (-) (+) (+) (-) Descartes Rule: There could be as many IRRs as there are sign changes.19 . California State University-East Bay 2 .IRR and Non-conventional Cash Flows If Non-conventional CFs.

20 .Non-conventional CFs Example • Suppose an investment will cost $90.000 initially and will generate the following cash flows: Year 1: 132.000 Year 3: -150.000 • The required return is 15%.000 Year 2: 100. • Should we accept or reject the project? California State University-East Bay 2 .

000.66% Discount Rate California State University-East Bay 21 .35 0.55 IRR = 10.00 $0.3 0.000.00 -$8.000.000.00 -$4.25 0.00 0 0.05 0.1 0.2 0.45 0.NPV Profile $4.00 NPV -$2.00 $2.5 0.00 -$6.4 0.15 0.00 -$10.000.000.11% and 42.000.

11% which would tell you to Reject • You need to recognize that there are nonconventional cash flows and look at the NPV profile California State University-East Bay 2 . you would get an IRR of 10.22 . so you should Accept • If you use the financial calculator.Summary of Decision Rules • The NPV is positive at a required return of 15%.

23 . you can’t choose the other – Example: You can choose to attend graduate school next year at either Harvard or Stanford.IRR and Mutually Exclusive Projects • Mutually exclusive projects – If you choose one. but not both • Intuitively you would use the following decision rules: – NPV – choose the project with the higher NPV – IRR – choose the project with the higher IRR California State University-East Bay 2 .

43% 64.05 -400 325 200 22.17% 60. Which project should you accept and why? 24 .Example: Mutually Exclusive Projects Period 0 1 2 IRR NPV California State University-East Bay Project A Project B -500 325 325 19.74 The required return for both projects is 10%.

I = 10 ENTER CPT => 64.Example: Mutually Exclusive Projects A: CF. I = 10 ENTER CPT => 60.05 IRR CPT => 19. 2nd [CLR WORK] CF0 = -400 ENTER C01 = 325 ENTER F01 = 1 C02 = 200 ENTER NPV. 2nd [CLR WORK] CF0 = -500 ENTER C01 = 325 ENTER F01 = 1 C02 = 325 ENTER NPV.25 .74 IRR CPT => 22.43 B: CF.17 California State University-East Bay 2 .

00 -$20.00 Discount Rate California State University-East Bay 26 IRR for A = 19.00 $140.00 $120.3 .05 B 0.00 $60.15 0.00 $40.00 $80.1 0.43% IRR for B = 22.8% NPV A 0.17% Crossover Point = 11.00 $100.2 0.NPV Profiles $160.00 $0.00 0 -$40.00 $20.25 0.

Conflicts Between NPV and IRR • NPV directly measures the increase in value to the firm • Whenever there is a conflict between NPV and another decision rule.27 . you should always use NPV • IRR is unreliable in the following situations Non-conventional cash flows Mutually exclusive projects California State University-East Bay 2 .

- Conch CaseUploaded bysantosh kumar
- Finance Week 6Uploaded byIRPS
- CapitalUploaded by1010180
- Model AfricaUploaded byElver Neiser Guevara Vera
- LCC AnalizeUploaded bybatazivo
- IrrUploaded byShahab Udin
- Victoria Chemicals Part 1Uploaded bycesarvirata
- Calculate IRR in ExcelUploaded byrahulchutia
- Methods criteriaUploaded byFanc Fanciv
- Ccim Financial Calculator v 6 1Uploaded byradi
- Super-IUploaded byAstha Suri
- 20170404162102new_heritage_dolls_fact_sheet.docxUploaded byCarlos
- AU FINC 501 MidTerm Exam 2nd Semester2015ss V2Uploaded bySomera Abdul Qadir
- Chapter 6 SlidesUploaded byRobert Zehbe
- Sample on Financial Analysis from Instant AssignmentUploaded byInstant Assignment Help Australia
- Cram SheetUploaded byJJJJ J JHJJ
- FIN 575 TUTOR Learn by Doing / fin575tutor.comUploaded byveeru66
- MKL - Primus - CopyUploaded byanything-a2
- AC 3 - Aurora Textile Company (1)Uploaded bySarmad
- MIT11_202F10_rec2Uploaded bypolobook3782
- Capital Budgeting Practices- A Survey of Central and Eastern European FirmsUploaded bymahesa
- ch26Uploaded byJohnny Walker
- ADM 2350N Quiz 2 V1 Winter 2010Uploaded by肖扬
- 733-1521-1-PBUploaded byboydaemon
- Sugar Mill in Bolivia - Financial Feasibility 2010Uploaded bymarianove
- Contoh Format Tk21 Revised Assignment5Uploaded byNaufal
- Session 3Uploaded bySankar Das
- Modelo de Plan de AcciónUploaded bytoocool2
- Broiler FsUploaded byAlfredo Jr Beltran
- invretB.pdfUploaded bymanishpareta5

- Cost of Capital_ Chapter 10Uploaded byhayward2sac
- Fall 2001 closed stat testUploaded byhayward2sac
- Fall 2005 closed book stat testUploaded byhayward2sac
- fall 2004 closed stat testUploaded byhayward2sac
- Bonds and Bond Valuation_chapter 5Uploaded byhayward2sac
- Fall 2004 closed book stat testUploaded byhayward2sac
- Capital Structure_chapter 16Uploaded byhayward2sac
- Fall 2001 closed stat testUploaded byhayward2sac
- Biostat6651_Lecture4Uploaded byhayward2sac
- Biostat6651_Lecture3_rev1Uploaded byhayward2sac
- Time Value of Money_chapter 2Uploaded byhayward2sac
- Ethanol MadnessUploaded byhayward2sac
- Acct 3230 Project OneUploaded byhayward2sac
- Biostat6651_Lecture2Uploaded byhayward2sac
- Chapters 3 12 Financial Statements Cash Flow Estimation (1)Uploaded byhayward2sac