FINC 3610 Exam 3 (Dismukes)\\\ FINC 3610 Exam 3
(Dismukes) 2025 – Complete Study Guide & Key
Concepts
Net Present Value (NPV)
a measure of how much value is created or added today by undertaking an investment
- numeric ($) value
- best option/always choose
- accept inv. if mkt value is greater
- benefits > costs then "creating value" => invest
- has to be positive
The NPV is the difference between...
the investment's market value and its cost
NPV Rule
investment should be accepted if the net present value is positive and rejected if it is negative
*assumes CF's reinvested at cost of capital
How to solve for NPV:
Estimate future cash flows
- Calculate the PV of Future CF's - initial cost
Internal Rate of Return (IRR)
the discount rate that makes the NPV = 0
- the breakeven
*Beware of Nonconventional Cash Flows*
How to solve for IRR:
set NPV = 0 and solve for "r" (YTM on bonds)
IRR Rule
An investment is acceptable if the IRR exceeds the required rate of return. It should be rejected
otherwise
*Assumes cash flows are reinvested at the IRR
What to beware for IRR:
may result in multiple answers (non-conventional CF's)
may result in incorrect decisions (mutually exclusive investments)
What does the Net Present Profile provide?
, - range of rates where NPV is positive
- range of rates where NPV is negative
- point of which NPV = 0 (IRR)
- Sensitivity of NPV to r (slope)
Mutually Exclusive Projects can cause what?
problems
Crossover Rate
1. Calculate (incremental CF's)
2. Calculate IRR based on incremental CF's
Modified Internal Rate of Return (MIRR)
- calculation of IRR on modified cash flows
(cash outflows discounted to time zero and cash inflows to end of project)
- combination approach, it is the discount rate that equates the present value of all cash outflows to the
future value of all cash inflows
How to solve for MIRR
For the combination approach, discount all cash outflows to time 0 and compound all cash inflows to
the end of the project
cant get multiple answers under this approach
MIRR Rule
An investment is acceptable if the MIRR exceeds the required rate of return
- should be rejected otherwise
*Assumes cash flows are reinvested at the cost of capital
Profitability Index (PI)
PV of future CF's / initial cost (absolute value)
- result will be a number that you compare to 1
- Also called a benefit-cost ratio
How to solve for PI
Calculate the present value of the future cash flows (the PV not the NPV) and divide by the initial cost. If
a project has a positive (negative) NPV, the PI will be greater (less) than 1
PI Rule
Only accept projects with a PI greater than 1, and invest in projects with the largest PI's first
The 4 Investment criteria related to NPV
NPV, IRR, MIRR, PI
(Dismukes) 2025 – Complete Study Guide & Key
Concepts
Net Present Value (NPV)
a measure of how much value is created or added today by undertaking an investment
- numeric ($) value
- best option/always choose
- accept inv. if mkt value is greater
- benefits > costs then "creating value" => invest
- has to be positive
The NPV is the difference between...
the investment's market value and its cost
NPV Rule
investment should be accepted if the net present value is positive and rejected if it is negative
*assumes CF's reinvested at cost of capital
How to solve for NPV:
Estimate future cash flows
- Calculate the PV of Future CF's - initial cost
Internal Rate of Return (IRR)
the discount rate that makes the NPV = 0
- the breakeven
*Beware of Nonconventional Cash Flows*
How to solve for IRR:
set NPV = 0 and solve for "r" (YTM on bonds)
IRR Rule
An investment is acceptable if the IRR exceeds the required rate of return. It should be rejected
otherwise
*Assumes cash flows are reinvested at the IRR
What to beware for IRR:
may result in multiple answers (non-conventional CF's)
may result in incorrect decisions (mutually exclusive investments)
What does the Net Present Profile provide?
, - range of rates where NPV is positive
- range of rates where NPV is negative
- point of which NPV = 0 (IRR)
- Sensitivity of NPV to r (slope)
Mutually Exclusive Projects can cause what?
problems
Crossover Rate
1. Calculate (incremental CF's)
2. Calculate IRR based on incremental CF's
Modified Internal Rate of Return (MIRR)
- calculation of IRR on modified cash flows
(cash outflows discounted to time zero and cash inflows to end of project)
- combination approach, it is the discount rate that equates the present value of all cash outflows to the
future value of all cash inflows
How to solve for MIRR
For the combination approach, discount all cash outflows to time 0 and compound all cash inflows to
the end of the project
cant get multiple answers under this approach
MIRR Rule
An investment is acceptable if the MIRR exceeds the required rate of return
- should be rejected otherwise
*Assumes cash flows are reinvested at the cost of capital
Profitability Index (PI)
PV of future CF's / initial cost (absolute value)
- result will be a number that you compare to 1
- Also called a benefit-cost ratio
How to solve for PI
Calculate the present value of the future cash flows (the PV not the NPV) and divide by the initial cost. If
a project has a positive (negative) NPV, the PI will be greater (less) than 1
PI Rule
Only accept projects with a PI greater than 1, and invest in projects with the largest PI's first
The 4 Investment criteria related to NPV
NPV, IRR, MIRR, PI
