NPV example Period Discount factor Cash F| ow Present∨aue 0 150.000 150.000 0.935 100000 93500 0.873 +300000 +261,000 Discount rate =7% NPV= $18,400
NPV example Period Discount Factor Cash Flow Present Value 0 1 -150,000 -150,000 1 0.935 -100,000 -93,500 2 0.873 +300000 +261,000 Discount rate = 7% NPV = $18,400
Points to keep in mind about nPv Assumes only one course of action Reasonable assumption if conditions are stable No room for managerial flexibility Choice of the discount rate is difficult Typically, use a combination of equilibrium models(like CAPM)and"expert judgment Should always perform sensitivity analysis on discount rate
Points to keep in mind about NPV • Assumes only one course of action: – Reasonable assumption if conditions are stable – No room for managerial flexibility • Choice of the discount rate is difficult: – Typically, use a combination of equilibrium models (like CAPM) and “expert judgment” – Should always perform sensitivity analysis on discount rate!
Payback ·| nvestment decision based on“ time it takes to recover investment No discounting of cash flows Gives equal weigh ht to cash flows before cut-off date no weight to cash flows after cut-off date Cannot distinguish between projects with different NPV Difficult to decide on appropriate cut-off dat
Payback • Investment decision based on “time it takes to recover investment” • No discounting of cash flows • Gives equal weight to cash flows before cut-off date & no weight to cash flows after cut-off date • Cannot distinguish between projects with different NPV • Difficult to decide on appropriate cut-off date
Payback example Project C NPV@10% Payback 2.000+1.000+1.000+5000 3,492 2 ABc 2.000 0+2000+5000 3.409 2,000+1,000+1,000+100,000 74.867
Payback example Project C 0 C1 C 2 C 3 NPV @ 10% Payback A -2,000 +1,000 +1,000 +5,000 3,492 2 B -2,000 0 +2000 +5,000 3,409 2 C -2,000 +1,000 +1,000 +100,000 74,867 2
Discounted payback Payback criterion modified to account for the time value of money Cash flows before cut-off date are discounted Surmounts objection that equal weight is given to all flows before cut-off date Cash flows after cut-off date still not given any weight
Discounted payback • Payback criterion modified to account for the time value of money – Cash flows before cut-off date are discounted • Surmounts objection that equal weight is given to all flows before cut-off date • Cash flows after cut-off date still not given any weight