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What is Net Present Value?
The difference between an investment's market value and its cost
What is Discounted Cash Flow Valuation?
The process of valuing an investment by discounting its future cash flows.
With NPV, when should an investment be accepted or rejected?
An investment should be accepted if the NPV is positive and rejected if it is negative.
What is the Payback Period?
The amount of time required for an investment to generate cash flows to recover its inital cost.
What is the Discounted Payback Period?
the length of time required for an investments discounted cash flows to equal its initial cost.
Based on the payback rule, when should an investment be accepted?
an investment is acceptable if its calculated payback is less than some prespecified number of years.
What is the Internal Rate of Return (IRR)?
The discount rate that makes the NPV of an investment zero.
Based on IRR, when is an investment accepted or rejected?
An investment is acceptable if the IRR exceeds the required return. It should be rejected otherwise.
What is the Net Present Value Profile?
A graphical representation of the relationship between an investments NPV and various discount rates.
What is the Multiple Rates of Return?
one potential problem in using the IRR method if more than one discount rate makes the NPV of an investment zero.
What are Mutually Exclusive Investment Decisions?
one potential problem in using the IRR method is the acceptance of one project excludes that of another.
IRR and NPV rule always lead to identical decisions as long as:
1) The first cash flow(s) is/are negative and all the rest are positive.
2) The decision to accept/reject the project does not affect the decision to accept/reject any other.
What is the Profitability Index (PI)?
the present value of an investment's future cash flows divided by its initial cost.
(Also the benefit/cost ratio)
Finance 258 Chapter 9 notes