1. Ch. 8: Net Present Value and Other Investment Criteria
The Payback Rule
The Average Accounting Return
The Internal Rate of Return
The Profitability Index

2. Decision Rules for Capital Budgeting
NPV is the correct rule
Other rules are commonly used, are simpler, but can give wrong answers
Each rule has advantages & disadvantages
Evaluation of decision rules:
Does the rule adjust for time value of money?
Does the rule adjust for risk?
Is the rule based on creating value for the firm?

3. 1. Net Present Value Each cash flow is net (inflow - outflow)
Ch. 9 & 12: WACC
“The difference between an investment’s market value and its cost” (p. 209)
The Net Present Value Rule
HP 10B calculation
Excel’s NPV glitch (p. 211)

4. Example a) Suppose WACC = 15%, initial CF = -$70,000,
and cash flows after 1-5 years are $10,000,
$30,000, $30,000, $30,000 and $10,000.
b) Re-calculate for WACC = 18%.
HP-10B: clear all; set P/YR=1, I/YR=15;
enter -$70,000 and press CFj; enter remain-
ing data, pressing CFj for each, and press
NPV to get net present value of this project =
If I/YR=18, NPV =
Excel, etc.: be sure CF0 is not discounted.

5. Comparing NPVs

6. 2. The Payback Rule
Payback is the length of time to recover the original investment
The Payback Rule
Advantages:
Disadvantages:

7. 3. The Average Accounting Return
AAR = Ave. Net Income/Ave. Book Value
The Average Accounting Return Rule
Advantages:
Disadvantages:

8. 4. Internal Rate of Return
IRR is the discount rate that forces the NPV of a project to equal zero
The IRR Rule:
NPV Profile
HP-10B calculation
Advantages:
Disadvantages:

9. 5. The Profitability Index
PI = PV of future cash flows/initial cost
The Profitability Index Rule
Advantages:
Disadvantages:

10. Recommended Practice Self-Test Problems 8.1 - 8.3 on pp. 229-30
Questions 2, 9, 11 on pp
Problems on pp : 3, 5, 9, 11, 13, 15, (answers are on p. 548)