FINC 3610 Exam 3 2025 – Complete Study
Guide & Key Concepts
Net Present Value (NPV) - ANSWER ✨✔---PV is a measure of how much value is created or added
today by undertaking an investment (the difference between the investment's market value and its
cost).
NPV = - ANSWER ✨✔---Estimate future cash flows. Calculate the present value of those cash flows
minus the initial cost.
NPV example: You plan to buy a machine that will cost $2,000 today and produce cash flows of $1,500 in
each of the next two years. The salvage value will be zero. The cost of capital is 15 percent. Should you
buy the machine? - ANSWER ✨✔---|----------------|----------------|-------------->
-2000 1500 1500
1500/ .15 = 6,666.67
1500 / (.15)^2 = 1,134.22
N= 2 , Int = 15, PV = ? , PMT = 1500 , FV= 0
= $2,438.56
2,438 > 2,000
,NPV rule: - ANSWER ✨✔---An investment should be accepted if the net present value is
_positive_and rejected if it is _negative_.
*Assumes cash flows are reinvested at _cost of capital_
Pros NPV: - ANSWER ✨✔----uses all cash flows
- adjusts for time value of money
Cons NPV: - ANSWER ✨✔---- need appropriate discount rate
- relatively more difficult to communicate
Internal rate of return - ANSWER ✨✔---The internal rate of return is the discount rate that makes
the net present value of a project equal to zero.
How to find initial rate of return - ANSWER ✨✔---Set NPV equal to zero and solve for "r".
Calculating IRR is identical to calculating the yield to maturity on bonds.
IRR example: You plan to buy a machine that will cost $2,000 today and produce cash flows of $1,500 in
each of the next two years. The salvage value will be zero. The cost of capital is 15 percent. Should you
buy the machine? - ANSWER ✨✔---N = 2 , int = ? , PV = -2000, PMT = 1500, FV = 0
INT= 31.8729
The rule of IRR: - ANSWER ✨✔---An investment is acceptable if the IRR exceeds the _required rate
of return or cost of capital_. It should be rejected otherwise.
-*Assumes cash flows are reinvested at _the IRR_.
Pros IRR: - ANSWER ✨✔----Closely related to the NPV rule
-Relatively easier to communicate
Cons IRR: - ANSWER ✨✔---- may result in multiple answerwers (non conventional cash flows)
, - may result in incorrect decisions (mutually exclusive investments)
The better method of estimating return is - ANSWER ✨✔---NPV
Independent projects - ANSWER ✨✔---only looking at one project and deciding to invest or not
If you have a choice between two projects, - ANSWER ✨✔---use the NPV bc IRR doesnt always tell
you everything you need to know
Net present value profile - ANSWER ✨✔---a graph showing the relationship between a project's
NPV and various discount rates
Information a NPV profile provides: - ANSWER ✨✔---1. Discount rates where NPV is positive -
accept
2. Discount rates where NPV is negative - reject
3. Discount rates where NPV is zero - IRR
4. Sensitivity of NRV to our discount rate (ex: slope)
Non conventional cash flow example: Assume you are considering a project with the following cash
flows:
Year Cash Flows
0 -$ 252
1 $1,431
2 -$3,035
3 $2,850
4 -$1,000 - ANSWER ✨✔---calculate the NPV:
-at 25.00%: NPV = _0_
-at 33.33%: NPV = _0_
-at 42.86%: NPV = _0_
-at 66.67%: NPV = _0_
Guide & Key Concepts
Net Present Value (NPV) - ANSWER ✨✔---PV is a measure of how much value is created or added
today by undertaking an investment (the difference between the investment's market value and its
cost).
NPV = - ANSWER ✨✔---Estimate future cash flows. Calculate the present value of those cash flows
minus the initial cost.
NPV example: You plan to buy a machine that will cost $2,000 today and produce cash flows of $1,500 in
each of the next two years. The salvage value will be zero. The cost of capital is 15 percent. Should you
buy the machine? - ANSWER ✨✔---|----------------|----------------|-------------->
-2000 1500 1500
1500/ .15 = 6,666.67
1500 / (.15)^2 = 1,134.22
N= 2 , Int = 15, PV = ? , PMT = 1500 , FV= 0
= $2,438.56
2,438 > 2,000
,NPV rule: - ANSWER ✨✔---An investment should be accepted if the net present value is
_positive_and rejected if it is _negative_.
*Assumes cash flows are reinvested at _cost of capital_
Pros NPV: - ANSWER ✨✔----uses all cash flows
- adjusts for time value of money
Cons NPV: - ANSWER ✨✔---- need appropriate discount rate
- relatively more difficult to communicate
Internal rate of return - ANSWER ✨✔---The internal rate of return is the discount rate that makes
the net present value of a project equal to zero.
How to find initial rate of return - ANSWER ✨✔---Set NPV equal to zero and solve for "r".
Calculating IRR is identical to calculating the yield to maturity on bonds.
IRR example: You plan to buy a machine that will cost $2,000 today and produce cash flows of $1,500 in
each of the next two years. The salvage value will be zero. The cost of capital is 15 percent. Should you
buy the machine? - ANSWER ✨✔---N = 2 , int = ? , PV = -2000, PMT = 1500, FV = 0
INT= 31.8729
The rule of IRR: - ANSWER ✨✔---An investment is acceptable if the IRR exceeds the _required rate
of return or cost of capital_. It should be rejected otherwise.
-*Assumes cash flows are reinvested at _the IRR_.
Pros IRR: - ANSWER ✨✔----Closely related to the NPV rule
-Relatively easier to communicate
Cons IRR: - ANSWER ✨✔---- may result in multiple answerwers (non conventional cash flows)
, - may result in incorrect decisions (mutually exclusive investments)
The better method of estimating return is - ANSWER ✨✔---NPV
Independent projects - ANSWER ✨✔---only looking at one project and deciding to invest or not
If you have a choice between two projects, - ANSWER ✨✔---use the NPV bc IRR doesnt always tell
you everything you need to know
Net present value profile - ANSWER ✨✔---a graph showing the relationship between a project's
NPV and various discount rates
Information a NPV profile provides: - ANSWER ✨✔---1. Discount rates where NPV is positive -
accept
2. Discount rates where NPV is negative - reject
3. Discount rates where NPV is zero - IRR
4. Sensitivity of NRV to our discount rate (ex: slope)
Non conventional cash flow example: Assume you are considering a project with the following cash
flows:
Year Cash Flows
0 -$ 252
1 $1,431
2 -$3,035
3 $2,850
4 -$1,000 - ANSWER ✨✔---calculate the NPV:
-at 25.00%: NPV = _0_
-at 33.33%: NPV = _0_
-at 42.86%: NPV = _0_
-at 66.67%: NPV = _0_
