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NPV IRR and Payback Period Rex Wu

The document discusses key capital budgeting techniques: Net Present Value (NPV), Internal Rate of Return (IRR), and Discounted Payback Period. NPV is calculated by subtracting the initial investment from the present value of cash inflows, with a positive NPV indicating project acceptance. IRR represents the project's return rate, and the Discounted Payback Period measures the time to recover the initial investment, providing essential decision criteria for investment evaluation.

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36 views9 pages

NPV IRR and Payback Period Rex Wu

The document discusses key capital budgeting techniques: Net Present Value (NPV), Internal Rate of Return (IRR), and Discounted Payback Period. NPV is calculated by subtracting the initial investment from the present value of cash inflows, with a positive NPV indicating project acceptance. IRR represents the project's return rate, and the Discounted Payback Period measures the time to recover the initial investment, providing essential decision criteria for investment evaluation.

Uploaded by

akhila
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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Download as PDF, TXT or read online on Scribd
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NPV, IRR, and Discounted payback

period
Yu-Kai Wu
(Rex)
IPhone 6 and NPV

© 2012 Pearson Prentice Hall. All rights reserved. 10-2


Net Present Value (NPV)

Net present value (NPV) is a sophisticated capital budgeting


technique; found by subtracting a project’s initial investment from the
present value of its cash inflows discounted at a rate equal to the firm’s
cost of capital.

NPV = Present value of cash inflows – Initial investment

© 2012 Pearson Prentice Hall. All rights reserved. 10-3


Net Present Value (NPV)

Decision criteria:
• If the NPV is greater than $0, accept the project.
• If the NPV is less than $0, reject the project.

If the NPV is greater than $0, the firm will earn a return greater than its
cost of capital. Such action should increase the market value of the
firm, and therefore the wealth of its owners by an amount equal to the
NPV.
© 2012 Pearson Prentice Hall. All rights reserved. 10-4
Net Present Value (NPV):
NPV and the Profitability Index

For a project that has an initial cash outflow followed by cash inflows,
the profitability index (PI) is simply equal to the present value of cash
inflows divided by the initial cash outflow:

When companies evaluate investment opportunities using the PI, the


decision rule they follow is to invest in the project when the index is
greater than 1.0.
© 2012 Pearson Prentice Hall. All rights reserved. 10-5
Internal Rate of Return (IRR)

The Internal Rate of Return (IRR) is a sophisticated capital


budgeting technique; it is the rate of return that the firm will earn if it
invests in the project and receives the given cash inflows.

© 2012 Pearson Prentice Hall. All rights reserved. 10-6


Internal Rate of Return (IRR)

Decision criteria:
• If the IRR is greater than the cost of capital, accept the project.
• If the IRR is less than the cost of capital, reject the project.

These criteria guarantee that the firm will earn at least its required
return. Such an outcome should increase the market value of the
firm and, therefore, the wealth of its owners.
© 2012 Pearson Prentice Hall. All rights reserved. 10-7
Discounted Payback Period

• A discounted payback period gives the number of years it takes to break


even from undertaking the initial expenditure.

© 2012 Pearson Prentice Hall. All rights reserved. 10-8


Discounted Payback Period

© 2012 Pearson Prentice Hall. All rights reserved. 10-9

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