1. 1 Estimated Cash Flows for Two Projects (S and L) Cost of Capital =.10 YearProject SProject L 0($1,000)($1,000) 1 500 100 2 400 300 3 300 400 4 100 600

2. 2 Payback Period Project SProject L (1,000)Total(1,000)Total 500 500 100 100 400 900 300 400 3001,200 400 800 1001,300 6001,400 Payback for Project S = 2.33 years Payback for Project L = 3.33

3. Discounted Payback – Project S 500 x (1.10) ^-1 = 454.54454.54 400 x (1.10) ^-2 = 330.57785.11 300 x (1.10) ^-3 = 225.391010.59 100 x (1.10) ^-4 = 68.301078.80 Discounted Payback = 2.95 3

4. 4 Net Present Value (NPV) NPV S = 500(1.1) -1 + 400(1.1) -2 + 300(1.1) -3 + 100(1.1) -4 - 1000 = 454.54 + 330.57 + 225.39 + 68.30 - 1000 = 78.80 NPV L = 100(1.1) -1 + 300(1.1) -2 + 400(1.1) -3 + 600(1.1) -4 - 1000 = 90.90 + 247.93 + 300.52 + 409.80 - 1000 = 49.15 Decision Rule 1) If NPV ≥ 0, Then Accept Project 2) If NPV < 0, Then Reject Project

5. 5 Internal Rate of Return (IRR) K NPV S 0 300.10 79 X 0 ?.15 -8.05 x 79/87 =.045 IRR S =.10 +.045 =.145 KNPV L 0400.10 49 X 0 ?.15 -80 05 x 49/129 =.018 IRR L =.10 +.018 =.118 Decision Rule 1) If IRR ≥ K, Then Accept Project 2) If IRR < K, Then Reject Project

6. 6 Example of What IRR Represents Deposit 1000 into a Bank Account Paying 14.5% per year: 1,000.00@14.5% 145.00Interest first year 1,145.00Amount in account at end of first year 500.00Withdraw 500 from account 645.00Amount remaining 93.53Interest second year 738.53Amount in account at end of second year 400.00Withdraw 400 from account 338.53Amount remaining 49.08Interest third year 387.61Amount in account at end of third year 300.00Withdraw 300 from account 87.61Amount remaining 12.39Interest fourth year 100.00Amount in account at end of fourth year 100.00Withdraw 100 from account 0.00Amount remaining

7. 7 Profitability Index PI = PV Future Cash Flows/NICO PI S = 1079/1000 = 1.079 PI L = 1049/1000 = 1.049 Decision Rule 1) If PI ≥ 1, Then Accept Project 2) If PI < 1, Then Reject Project

8. Average Rate of Return You are reviewing a new project and have estimated the following cash flows: –Year 0:CF = -165,000 –Year 1:CF = 63,120; NI = 13,620 –Year 2:CF = 70,800; NI = 3,300 –Year 3:CF = 91,080; NI = 29,100 –Average Book Value = 72,000 8

9. Average Rate of Return Assume we require an average accounting return of 25% Average Net Income: –(13,620 + 3,300 + 29,100) / 3 = 15,340 AAR = 15,340 / 72,000 =.213 = 21.3% Do we accept or reject the project? 9