MBA702 Module 3
Study online at https://quizlet.com/_f6g4ug
1. What is the best Net Present Value (NPV)
approach to com- -accept project if NPV is + and reject if it's -
pute if a project
is worth investing 1. NPV = Total PV of future CF - Initial investment
in?
2. Why is NPV the 1. It uses CF which is more objective
best method? 2. Uses all CF for project.
3. Uses discounts to do risk-return tradeoff
3. What does NPV 1. Estimate future CF (how much and when)
do 2. Estimate discount rate
3. Estimate initial costs.
It is basically how much will you make from the project, already accounting for the
initial investment. NPV=0 is breaking even, want to accept projects where NPV is
greater than 0.
4. Payback Period How long until they get the ROI on the investment, the number of years until you
Method get the initial investment back. Criteria or threshold is set by management.
Issues is it ignores the value of money, cashflow after payback period, biased
against long term projects and not necessarily assoc with a + NPV. Period criteria
can be difficult to decide.
But it is easy to understand and biased towards liquidity.
5. Discounted Pay- Considers time value of money and is typically longer than the payback period. Still
back Period uses an arbitrary payback period.
6. Internal rate of IRR is the discount rate that sets NPV=0.
return Accept is IRR exceeds required return. So when all the future CF = the initial
investment. What rate will let you get your money back.
Choose the option with the highest IRR.
1/7
, MBA702 Module 3
Study online at https://quizlet.com/_f6g4ug
Goal is to find the range of discount rates where project is acceptable.
Doesn't account for untraditional cash flows(like if you get way more in year 2 than
year 1 or even if you lose $). but is easy to understand.
Can be graphed against NPV for analysis. IRR will be where NPV =0 on the graph
and the other coord is the discount rate
Doesn't scale ($1 vs $1000 issue). Mult IRR's could be in play, are we borrowing
or lending? doesn't take timing into account.
7. Easy to under- 1. NPV- what are you actually going to make
stand concepts of 2. Payback Period - when will you get your money back
all methods: 3. IRR- what rate will you get your money back
8. When is IRR rule when financing type projects, so accept a project if IRR is less than cost of capital
reversed?
9. Financing pro- Pays money
ject:
10. Investment pro- project that receives money.
ject
11. Mutually exclu- Only of several potential projects can be chosen, so rank all of them and choose
sive project the best one. Use NPV to decide here.
12. Independent Pro- A project whose acceptance or rejection is independent of the acceptance or
ject rejection of other projects. Doesn't affect another project
13. Modified IRR Make unconventional cash flow, conventional. Calc all NPV of all CF using borrowing
rate. Calc net future value of all cash inflows using investing rate. Find the rate of
return that equates these values(make the 2 rates = eachother). Benefits is that it
gives a single answer and specific rates for borrowing and reinvestment.
2/7
Study online at https://quizlet.com/_f6g4ug
1. What is the best Net Present Value (NPV)
approach to com- -accept project if NPV is + and reject if it's -
pute if a project
is worth investing 1. NPV = Total PV of future CF - Initial investment
in?
2. Why is NPV the 1. It uses CF which is more objective
best method? 2. Uses all CF for project.
3. Uses discounts to do risk-return tradeoff
3. What does NPV 1. Estimate future CF (how much and when)
do 2. Estimate discount rate
3. Estimate initial costs.
It is basically how much will you make from the project, already accounting for the
initial investment. NPV=0 is breaking even, want to accept projects where NPV is
greater than 0.
4. Payback Period How long until they get the ROI on the investment, the number of years until you
Method get the initial investment back. Criteria or threshold is set by management.
Issues is it ignores the value of money, cashflow after payback period, biased
against long term projects and not necessarily assoc with a + NPV. Period criteria
can be difficult to decide.
But it is easy to understand and biased towards liquidity.
5. Discounted Pay- Considers time value of money and is typically longer than the payback period. Still
back Period uses an arbitrary payback period.
6. Internal rate of IRR is the discount rate that sets NPV=0.
return Accept is IRR exceeds required return. So when all the future CF = the initial
investment. What rate will let you get your money back.
Choose the option with the highest IRR.
1/7
, MBA702 Module 3
Study online at https://quizlet.com/_f6g4ug
Goal is to find the range of discount rates where project is acceptable.
Doesn't account for untraditional cash flows(like if you get way more in year 2 than
year 1 or even if you lose $). but is easy to understand.
Can be graphed against NPV for analysis. IRR will be where NPV =0 on the graph
and the other coord is the discount rate
Doesn't scale ($1 vs $1000 issue). Mult IRR's could be in play, are we borrowing
or lending? doesn't take timing into account.
7. Easy to under- 1. NPV- what are you actually going to make
stand concepts of 2. Payback Period - when will you get your money back
all methods: 3. IRR- what rate will you get your money back
8. When is IRR rule when financing type projects, so accept a project if IRR is less than cost of capital
reversed?
9. Financing pro- Pays money
ject:
10. Investment pro- project that receives money.
ject
11. Mutually exclu- Only of several potential projects can be chosen, so rank all of them and choose
sive project the best one. Use NPV to decide here.
12. Independent Pro- A project whose acceptance or rejection is independent of the acceptance or
ject rejection of other projects. Doesn't affect another project
13. Modified IRR Make unconventional cash flow, conventional. Calc all NPV of all CF using borrowing
rate. Calc net future value of all cash inflows using investing rate. Find the rate of
return that equates these values(make the 2 rates = eachother). Benefits is that it
gives a single answer and specific rates for borrowing and reinvestment.
2/7
