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30 Cards in this Set
- Front
- Back
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NPV vs IRR methods
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NPV - highlights amounts, more conservative, assumes reinvestment @ hurdle rate
IRR - focuses decision makers on %, more agressive, assumes reinvestment @ IRR, less reliable. |
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Pay Back period (present value factor) =
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= Net incremental investment/ Net annual cash flows
No concideration of time |
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When do you accept IRR?
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when IRR>hurdle (targeted RRR) rate
Regect when IRR< or = hurdle (targeted) rate IRR> RRR when NPV =0 |
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Compute after tax cash flow
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= Pre-tax cash flow x (1- tax rate)
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4 steps to caculate NPV
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1. Compute after tax cash flow= Pre-tax cash flow x (1- tax rate)
2. Add depreciation benefit = Depreciation x tax rate 3. Multiply result by appropriate present value of annuity. 4 Subtract initial Cash outflow (Investment) |
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Pay back period =
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Net initial investment / Increase in annual net after - tax cash flow
or = Net initial investment / (operating savings + savings generated by depreciation) = Net initial investment / [Operating savings x (1-tax rate) + depreciation exp x tax rate] Increase in annual net after - tax cash flow = initial investment / payback period |
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When do you accept NPV?
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Investment should be made if NPV >0.
If company has unlimited funds- NPV > or =0. |
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NPV is superior to IRR because
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it is flexible enough to consistently handle either uneven cash flows or inconsistent rates of return for each year of the project.
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Accounting rate of return =
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= (Annual savings - Depreciation)/ Req. investment
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Profitability index =
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(PV of cash flows) / Initial investment
If Profitability index > 1 --> NPV > 0 It provides the means to rank capital projects w/ different amounts of investment |
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What Does Present Value Interest Factor Of Annuity - PVIFA Mean?
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A factor which can be used to calculate the present value of a series of annuities. The initial deposit, earning interest at the periodic rate (r), perfectly finances a series of (N) consecutive dollar withdrawals. PVIFA is also a variable used when calculating the present value of an ordinary annuity (is an annuity whose payments are made at the end of each period).
PVIFA = [- (1 + r)^-N]/r |
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What Does Present Value Interest Factor - PVIF Mean?
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Using the PVIF works best when you are attempting to discount one value in the future.
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What Does Internal Rate Of Return - IRR Mean?
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The discount rate often used in capital budgeting that makes the net present value of all cash flows from a particular project equal to zero.
=> PV factor x cash inflows = cash investment, solve for PV factor |
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Popular methods of capital budgeting include
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net present value (NPV), internal rate of return (IRR), discounted cash flow (DCF) and payback period.
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accounting rate of return (ARR)
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= (Net Cash flow - Depr.) / investment
- Does not consider the time value of money, It focuses on income and not CFlow Definition 1 Straight-line' method of estimating average returns from an investment, it uses accrual based financial statements instead of compounded or discounted cash flows. Also called book value method, financial statement method, or simple rate of return. Definition 2 Ratio that expresses the earnings before interest and taxes (EBIT) as a percentage of the capital employed at the end of an accounting period. |
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Return on investmen ROI ?
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Income/ Invested Capital
OR Return on Sales (Profit Margin) x Capital Turnover = Net income/Sales x Sales/Invested capital Disadvantage - may lead to rejecting projects that yield positive cash flows. |
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Net Present Value =
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= the PV of an investment's future net cash flows minus the initial investment.
If positive, the investment should be made (unless an even better investment exists), otherwise it should not. - the method that recognizes the time value of money by discounting the after- tax cash flows over the live of a project, given the company's minimum desired rate of return. |
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The payback period serves as a fair approximation of ?
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of the annity factor value used in estimaiting the IRR
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ROI return on investment =
Disadvantage - |
= net income/ invested capital
OR Profit Margin (Return on Sale) x Investment Turnover Disadvantage - may lead to rejecting projects that yield positive cash flows. |
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NPV =
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CF- investment
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Probability formula
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1)find Change in Market Value
2) Probability factor X Change in value = Cost of investment |
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The method that recognizes the time value of monew by discounting the after-tax cash flows over life of a project, given the company's minimum rate of return is
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NET PRESENT VALUE METHOD
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The discounted payback period id the length of the time required
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for discounted cash flows to recover the cost of the investment.
Investment= PVF yr.1 x CF yr1+PVFyr2 x CFyr.2... |
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If the discount rate is increased, the PV of the future cash flows will ________
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decrease
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The profitability index is also known as
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the excess present value index.
it is a variation of NPV |
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Short-term interest rates are generally ______ than long-term rates
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LOWER
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The payback method doesn't take into account __________
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the life of the asset, its salvage value or depreciation.
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Profitability index =
NPV = PROJECT Profitability index = |
PV of CF / Investment
PV of CF - Investment NPV/ Investmen |
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As Interest Rate get higher, the PV FACTOR for the same number of periods becomes ___________
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smaller.
Smaller FVFactor - HIGHER % RATE |
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The DISCOUNTED PAYBACK PERIOD is the length of time req. for discounted cash flows to recover the cost of the investment. If the DCB is 3 years than INVESTMENT =
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RV of CF YEAR 1 + PV of CF YEAR 2 + PV of CF YEAR 3
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