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17 Cards in this Set

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A dollar today is worth more than a year from now. Therefore, projects today that promise earlier returns are preferable to those that promise later returns

true

the capital budgeting techniques that best recognize the time value of money are those that involve

discounted cashflows




NPV and IRR

Payback

length of time it takes for a project to recoup its initial cost

Payback formula

investment required/annual net cash inflow

What sucks about payback? 3 ways

Ignores time value of money




shorter payback doesn't always mean more desirable investment




Ignores cash flow after payback period

Net Present Value

Compares present value of a projects cash inflows with the present value of cash outflows.


The difference between these two streams of cash flows is called the NPV

NPV positive or zero

acceptable because it promises a return greater than/equal to the required rate of return

NPV negative

not acceptable because it promises a return less than the required rate of return

Internal Rate of Return

rate of return promised by an investment over its useful life

How is IRR computed?

by finding the discount rate that will cause the NPV of a project to be zero

if the IRR is equal to or greater than the minimum required rate of return

then the project is acceptable

Capital budgeting decisions

screening decisions and preference decisions

Screening decisions

Pertain to whether or not an investment is acceptable, this decision comes first

Preference Decisions

Rank projects

the higher the internal rate of return

the more desirable the project

NPV of one project cannot be directly compares to the NPV of another unless investments are equal. If not, what must be calculated?

Profitability Index

Profitability Index

NPV/Investment Required