Ch 6 Project Analysis Under Certainty. Methods of evaluating projects when the future is assumed to be certain. Introduction. The ideal investment decision making technique is Net Present Value . N P V measures the equivalent present wealth contributed by the investment. NPV is given in
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Methods of evaluating projects when the future is assumed to be certain.
The ideal investment decision making technique is Net Present Value.
N P V measures the equivalent present wealth contributed by the investment.
NPV is given in
NPV -- relates directly to the firm’s goal of wealth maximization
-- employs the time value of money
-- can be used in all types of investments
-- can be adjusted to incorporate risk.
Discounted Cash Flow Techniques
Internal Rate of Return – calculates the discount rate that gives the project an NPV of $0. If the IRR is greater than the required rate, the project is accepted. IRR is given as % pa.
Modified Internal Rate of Return – calculates the discount rate that gives the project an NPV of $0, when future cash flows can be re-invested at the Re-Investment Rate, a rate different from the IRR. If the MIRR is greater that the required rate, the project is accepted. MIRR is given as % pa.
Non-Discounted Cash Flow Techniques
Accounting Rate of Return- measures the ratio of annual average accounting income to an asset base value. ARR is given as % pa.
= % pa.
Payback Period – measures the length of time required to retrieve the initial cash outlay.
PB is given as number of years.
NPV is the technique of choice; it satisfies the requirements of: the firm’s goal, the time value of money, and the absolute measure of investment.
IRRis useful in a single asset case, where the cash
flow pattern is an outflow followed by all positive
inflows. In other situations the IRR may not rank
mutually exclusive assets properly, or may have
zero or many solutions.
End Of Year cash flow timing is assumed.
0 1 2 3 4 5
Initial Later Terminal
Outlay. Outlay Flow
0 1 2 3 4 5
EOY 1 300
EOY 2 380
EOY 3 600
The NPV is calculated.
NPV = $ 224.97 Positive: the project is acceptable.
4 8 12 16
THE model to use in all investment evaluations.
Other criteria, such as IRR, MIRR, ARR, and Payback may be used as complementary measures.