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Ch 6 Project Analysis Under Certainty
Methods of evaluating projects when the future is assumed to be certain.
1
Introduction
The ideal investment decision making technique is Net Present Value.
N P V measures the equivalent present wealth contributed by the investment.
NPV is given in
NPV -- relates directly to the firm’s goal of wealth maximization
-- employs the time value of money
-- can be used in all types of investments
-- can be adjusted to incorporate risk.
Other Project Evaluation Techniques: Slide I
Discounted Cash Flow Techniques
Internal Rate of Return – calculates the discount rate that gives the project an NPV of $0. If the IRR is greater than the required rate, the project is accepted. IRR is given as % pa.
$0(NPV) =
CF
(1+ IRR)1
+
CF2 (1+ IRR)2
...... IO
3
Other Project Evaluation Techniques: Slide II
Modified Internal Rate of Return – calculates the discount rate that gives the project an NPV of $0, when future cash flows can be re-invested at the Re-Investment Rate, a rate different from the IRR. If the MIRR is greater that the required rate, the project is accepted. MIRR is given as % pa.
$0(NPV) =
CF ´(1+ RIR)n
(1+ IRR)1
+ CF2
´(1+ RIR)(n
(1+ IRR)2
1)
...... IO
4
Other Project Evaluation Techniques: Slide III
Non-Discounted Cash Flow Techniques
Accounting Rate of Return- measures the ratio of annual average accounting income to an asset base value. ARR is given as % pa.
= % pa.
Payback Period – measures the length of time required to retrieve the initial cash outlay.
PB is given as number of years. 5
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