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Flashcards in Investement Deck (7):


IRR is the discount rate at which NPV equals zero


Rule of IRR

Invest in any project offering a rate of return that is higher than the opportunity cost of capital


3 issues with IRR

Mutually exclusive projects
Doesn’t differentiate between lending and borrowing projects
When lots of changes to sign + or -


Payback ads

Straightforward method
It’s important - long payback period means capital will be tied up for a long period implying in turn, high investment risk


Payback dis

Ignores the timing of cash flows
The risk of investment + cash flows occurring after the payback period

Most importantly it doesn’t consider the shareholders wealth maximisation objective


Ads of NPV

Accounts for all expected cash flows of the investment, the timing of these cash flows and the risk of the investment

Most impotent the method takes into consideration the shareholders wealth maximisation objective


Dis of NPV

The method can fail to be an effective decision criterion when capital rationing exists

In such cases it need to be complemented by the profitability index in order to rank the investments