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Financial Decision Making and Loan Acceptance Criteria

Explore the factors that influence loan acceptance decisions, including interest rates, discount rates, and internal rates of return. Analyze sample cash flows and investment projects to understand the implications on net present value and IRR. Learn how to determine the Minimum Attractive Rate of Return (MARR) and evaluate project worthiness based on NPV and IRR criteria in capital budgeting.

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Financial Decision Making and Loan Acceptance Criteria

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  1. Question • Suppose you were offered a loan. What would make you more inclined to accept it? • a decrease in the loan’s interest rate? • a decrease in your discount rate? • Why does the IRR of the following cash-flow not exist? • Pay $250 now and pay $100 in two years

  2. Potential Projects (N p489) • Cost $100k, IRR=20% • Cost $200k, IRR=15% • Cost $50k, IRR=25% • Cost $100k, IRR=20% • Cost $100k, IRR=20% • Cost $100k, IRR=18% • Cost $300k, IRR=10% • Cost $300k, IRR=12% • Cost $50k, IRR=14% • Budget $650k • MARR = IRR of highest ranked unfunded project

  3. Summary • IRR = d  NPV(d) = 0 • For investments: NPV(d) > 0  IRR > d • For loan: NPV(d) > 0  IRR < d • MARR = “Minimum Attractive Rate of Return” • discount rate • “external rate of return” • rate of return of best external alternative • NPV > 0 implies • project worth doing • Usual criterion: • alternative with largest NPV is best

  4. More… • Investment project cashflows • first negative then positive and NPV(d) is … … decreasing • NPV(d) increasing for loans • IRR • Don’t need MARR. • Can be used in capital budgeting to set MARR. • Problematic when cashflows switch signs more than once (or never)

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