Part 6 how to calculate (and really understand) return on Investment Flashcards
What is Future value
Future value is the amount of cash will be worth in the future if it is loaned out or invested.
What is Present value
Evaluating the expected value of some monetary sum of current dollars based on a perceived expectation on interest rate. e.g. if you have 100,000 dollars and you expect an interest rate of 6%, 106,000 dollars in twelve months is worth 100,000 dollars today
Opportunity Cost
What you had to give up to follow a certain course of action (buying x apples means you can’t buy y oranges)
What is Cap-ex
Capital Expenditures - large projects that require a significant investment of cash.
What are the three reasons Cap-ex purchase are treated differently from ordinary purchases?
1) Involve large amounts of cash
2) Typically expected to provide returns for several years
3) Always entail some degree of rish.
What are the three steps needed to determine if a capital expenditure is worth divulging money into
1) Analyzing a cap-ex to determine the initial cash outlay.
2) Project future cash flows.
3) evaluate the future cash flows
What is the Payback Method?
A way to evaluate the future cash flow from a capital expenditurs. It measures the time for cash flow from the project to return to the original investment. Must be shorter than the life of the project!
What are the positives of the payback method?
- Simple to calculate and explain.
- Provides a quick and easy reality check.
- can prove a project is worth/not worth pursuing.
Should only be used to compare projects or reject projects
What are three reasons the NPV is used/preferred?
- takes into account the time value of money.
- Considers a business’s cost of capital.
- Provides an answer in today’s dollars.
What is the discounting equation?
A method of calculated NPV, PV = (FV1/(1+i)) + (FV2/(1+i)^2 … FVn/(1+i)^n
NET present value is equal to present value minus the initial cash outlay
