Financial Management
Internal Rate of Return (IRR) for Investing Project Internal rate of return (IRR) is the discount rate that makes Net Present Value (NPV) of investment zero. NPV =sum of present value of each cash inflow – initial investment when NPV=0, so sum of present value of each cash inflow =initial investment Investing project has only one IRR. To determine
Continue reading THE AVERAGE ACCOUNTING RETURN (AAR) AAR=Average net income/Average book value Average book value or average investment can be exchanged Project Decision: AAR > target AAR, so accept the project AAR < target AAR, so reject the project Advantages for Average Accounting Return (AAR): Easy to calculate Needed information will usually be available. Disadvantages for Average Accounting Return (AAR): Not a
Continue reading THE DISCOUNTED PAYBACK Discounted payback period is the length of time required for an investment’s discounted cash flows to equal its initial cost. In general, if we use a discounted payback rule, we won’t accidentally take any projects with a negative estimated NPV, but this argument assume the cash flows, other than the first, are all positive. If they are
Continue reading THE PAYBACK RULE (PB) Payback period: the amount of time required for an investment to generate cash flows sufficient to recover its initial cost. A cutoff period is established Payback Rule (PB) method usually use with small investment project. There are two types of cash flows to calculate payback period: For annuity Payback period= initial investment/annual cash inflow For
Continue reading Net Present Value (NPV) for Capital Rationing In real situations, company may not have enough capitals to invest all profitable projects, so we need to choose projects that give optimal profit and meet with our capitals that have. Project Decision: Combined possible NPVs with available capitals and compare combined NPVs. For example, Combined NPVs (case 1) > Combined NPVs (case2),
Continue reading Net Present Value (NPV) for Mutually Exclusive Project Mutually exclusive project is different independent project. For mutually exclusive project, we can accept project A or B or deny both, but we cannot accept both projects. We may solve mutually exclusive projects using NPV with following two methods: Compare NPV if NPV(A)>NPV(B), so choose project A Compute incremental NPV solved via
Continue reading Net Present Value (NPV) for Independent Project Company may have some projects to make decision invest or not. The independent project is one whose acceptance or rejection is independent of the acceptance or rejection of the other projects. Project decision: if independent project NPV>0=> accept the project if independent project NPV<0=>reject the project if independent project NPV=0=>indifference Example: ABC Corporation
Continue reading How to Build Net Present Value (NPV) Profile/Graph NPV graph makes an easy way to visualize whether or not an investment should be undertaken. Three different points are important to build a NPV graph for a project as follows: Determine NPV value at zero discount rate ( r =0) Determine NPV value at any discount rate Determine discount rate value
Continue reading Net Present Value (NPV) for Mixture Project NPV for mixture project is mixed financing project and investing project, and its cash flows can be positive or negative after initial cash flow. NPV= initial cash flow – sum of present value of each cash outflow + sum of present value of each cash inflow Project decision: if NPV>0=> accept the project
Continue reading Financing Project NPV= Cash receipt – sum of present value of each cash outflow There are two types of sum of present value of each cash outflow: Annuity Not Annuity Project decision: if NPV>0=> accept the project if NPV<0=>reject the project if NPV=0=>indifference Example: Suppose you are offered $5,000 today but must make the following payments. Required 1.What is the
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