Week12 Flashcards
(15 cards)
what is the goal of capital budgeting
increase firm’s value
what is the goal of project valuation
to find projects that increase company’s value
what is the benefit of choosing projects with positiveNPV
they increase company value through increasing its cash flow. positive NPV, value of projects is positive. firm’s value measured through value of projects.
how do you calculate NPV
the present value today of all the expected cash flows - the present value today of any initial investments
NPV calculation when does it start
year 0 or year 1? well, you sum the cash flows at value t = 0. cash flows for NPV projects start at t = 1, cos at t = 0, you make the investment
what does NPV = 0 mean
taking on the project will only break even for the company, it doesnt bring positive or negative value for the company. it can just not take on the project.
what are the advantages of NPV
provide a method for evaluating economic benefit of project
need analyst to clearly state assumptions when calculating cash flow
what are the disadvantages of NPV
need to estimate discount rate
cash flows need to be forecasted (uncertainty plus dont know timing)
what is irr
the discount rate that sets NPV equal to 0
what is the irr rule
choose projects where Rirr > R (discount rate)
when do you use the positive NPV rule instead of the irr rule
when cash flows are alternating, and you have more than 1 irr. then you just take NPV
what is the target payback period
the number of years it takes to recover the initial investment
what is the payback method
you only invest if the initial investment into the project can be recovered before or on the target payback period
what are the advantages of the payback period
computationally easy
easy to understand
disadvantages of the payback period
doesnt consider cash flows after the payback period ends
doesnt consider discount rate (tvm concept)
