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CF 473.32 9 Winter 2014. Investment Criteria ch 9 you may remember some of this.

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Presentation on theme: "CF 473.32 9 Winter 2014. Investment Criteria ch 9 you may remember some of this."— Presentation transcript:

1 CF Winter 2014

2 Investment Criteria ch 9 you may remember some of this

3 What’s a Good Idea? assessing an investment option  is market value > cost? value creation for firm  in a rational market here’s an odd thing:  You should act as if the market is rational.  As a manager, responsible for the health of the firm, the rationality of the market is not your first concern. What matters most is your duty to the firm. »So you should do those things which, to the best of your knowledge, will create value for the firm. »“to the best of your knowledge”  “rationally”

4 NPV Is market value > cost?  How much value is created from undertaking an investment? given a required return (an r ), solve for NPV

5 IRR most important alternative to NPV set NPV = 0, solve for r

6 IRR disadvantages 1.mutually-exclusive projects 2.non-conventional cash flows  may have multiple answers no answer  if cash flows sign changes >1 use NPV instead -$8,000 -$4,000 $0 $4,000 25%50%

7 NPV “A Project” yearCFNI 0-$165, ,120$13, ,8003, ,08029,100 given: r = 12% solve for NPV

8 IRR yearCFNI 0-$165, ,120$13, ,8003, ,08029,100 given: NPV = 0 solve for r

9 IRR disadvantages 1.mutually-exclusive projects  doesn’t compare together  if IRR gives different answer than NPV trust NPV instead

10 What To Do? primary  NPV  IRR secondary  payback useful for explanation if payback-obsessed:  # years arbitrary  What about after?

11 What’s a Good Idea? assessing an investment option  is market value > cost?  time value  risk

12 common problems? considerseasy to time value risk value creation use explain NPV payback disc. payback  AAR  IRR profitability  Assessment Methods


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