Alternative Investment Rules in Capital Budgeting NPV vs. Payback Period (PP), Accounting ROR, and Internal Rate of Return (IRR) How Important is CB to a firm? Why is Capital Budgeting (CB) so critical to a firms long-term survival? Magnitude of $s involved: Amplifies both, the positive impact of good decisions, and negative impact of poor decisions Repercussions of CB decisions extend over
long periods of time Chhachhi/519/Ch. 6 2 Evaluation of Investment Rules Criterion to be used to judge investment rules: Uses Cash Flows and NOT earnings Uses ALL Cash flows Does NOT ignore Time Value of $ Makes Accept/Reject decisions that are consistent with S/H wealth Max.
Chhachhi/519/Ch. 6 3 NPV-- A benchmark for other Investment Rules! NPV: PV of future CFs - Initial Investment Accept if NPV > 0 (Independent Projects) In case of mutually exclusive (M.E.) projects, choose the highest NPV Accepting +NPV projects will Always increase S/H wealth and vice versa. Why look at other rules??
Chhachhi/519/Ch. 6 4 Payback Period (PP) Rule Length of time it takes for a firm to recover its investment if PP < a cutoff time: Accept Disadvantages Ignores Time Value of money Ignores CFs beyond Payback Period. Biased against Long-term projects
Cutoff time is arbitrarily decided Chhachhi/519/Ch. 6 5 PP Rule (continued) Advantages Easy to understand/use Favors liquidity might be appropriate for quick decisions for repetitive or low budget projects Read: discounted PP (sec. 6.3) & Average Accounting Return (sec. 6.4)
Chhachhi/519/Ch. 6 6 Internal Rate of Return (%) (IRR) The discount rate for which: PV of future CFs = Initial Investment OR NPV of the project = 0 Accept if IRR > Required return M.E.: select alternative with the highest IRR. IRR is independent of discount rate NPV profile: Discount rate, NPV graph
downward sloping Chhachhi/519/Ch. 6 7 Potential Problems with IRR (Independent OR M.E.) CF0 =$100, CF1 =-$130; r = 10% NPV = -$18.20, IRR = 30%; Accept???? NO; This is a Financing project for Financing, accept if IRR < r CF0 = -$60, CF1 =$155 CF2 = -$100; Multiple IRRs Neither has any economic meaning Possible if >1 reversal of sign of CFs
NPV does not have these 2 problems Chhachhi/519/Ch. 6 8 Potential Problems with IRR (M.E. projects only) Scale Problem: Comparing small and large projects: A: CF0 = -$100, CF1 = $150; r = 0% NPV = $50, IRR = 50% B: CF0 = -$1,000, CF1 = $1,250; NPV = $250, IRR = 25%
If r= 10%, S or L??? Chhachhi/519/Ch. 6 if r = 5%? 10 Reinvestment Assumption NPV: NPV rule assumes that all future CFs can be reinvested at the discount rate IRR: IRR calculation assumes that all future CFs can be reinvested at the IRR Which is more Realistic? IRR is easy to understand and communicate
Chhachhi/519/Ch. 6 11 Profitability Index (PI)& Capital Rationing PI: PV of future CFs/Initial Investment Accept if >1 (independent projects) Can lead to incorrect decision for M.E. (choosing highest PI) Similar to NPV Capital Rationing: Limited funds PI useful for making optimal decisions
A la contamination bactérienne vient s'ajouter une dévascularisation étendue des fragments osseux. ... Cal vicieux : Consolidation d'un foyer de fracture qui abouti à une altération structurelle de l'os.
HVAC, Industrial/Residential Electricity , Mechanical Maintenance , Precision Machining Technology , Welding . Career Studies Certificates. 21 Program Majors. John Tyler's Other Programs Of Study. Transfer Programs (AS or AA degrees) Business. General Studies.
A (Nev.) sues B (Cal.) and C (Oreg.) in California state court for batteryA asks for $80k each from B and CMay B and C remove? 1441(b)(2)A civil action otherwise removable solely on the basis of the jurisdiction under section...
Kantianism: Interactions with other people should respect them as rational beings. Utilitarians: You should consider the consequences of an action before deciding whether it's right or wrong. Social contract theory: We should promote collective rights, such as the rights to...
&LIBS is a list of library names, such as: MYLIB YOURLIB HISLIB HERLIB BIGLIBNAME. 2. &LIB is one library name. 3. The first CHGVAR command copies the first 10 bytes of &LIBS to &LIB. (We don't need %SST (substring) because...
Caleb: A Spy with a "Different Spirit" Caleb the son of Jephunneh Numbers 13 6 from the tribe of Judah, Caleb the son of Jephunneh; Different Servant Chosen by Moses to spy the land Selected for the service A different...