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NPV =
t =0
CF t
( 1+r )t
Cost is often
n
NPV =
t=1
CF t
( 1+r )t
CF 0
and is negative.
CF 0
Example 1
Given the following data and the opportunity cost of
capital is 10%.
Year
Project X
Project Y
0
-$100
-$100
1
10
70
2
60
50
3
80
20
Find the NPV of project X and of project Y.
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(
t=0
CF t
1+ r )
=NPV
(
t=0
CF t
1+ IRR )
=0
Example 2
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Example 4
Refer to example 1 data, if r = 0%; 5%; 10%, 15%;
20%; Find the NPVx and NPVy respectively. Sketch the
NPV profile and find the crossover rate.
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Example 5
Refer to example 1, find the MIRR of project X and
project Y.
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Profitability Index
The profitability index (PI) is the present value of
future cash flows divided by the initial cost.
PI =
PV future CF
Initial Cost
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Payback Methods
Payback period is the number of years required to
recover a projects cost, or how long it takes to get
the businesss money back.
Firms establish a benchmark payback period;
projects whose payback exceeds this benchmark are
rejected.
Strengths:
o Provides an indication of a projects risk and
liquidity.
o Easy to calculate and understand.
Weaknesses:
o Ignores the time value of money.
o Ignores CFs occurring after the payback period.
Example 7
Refer to example 1, find the payback period for project X and
project Y.
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Discounted Payback
Uses discounted rather than raw CFs.
Example 8
Refer to example 1, find the discounted payback period of
project X and project Y.
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Example 9
Which project should be adopted given they are mutually
exclusive and the opportunity cost of capital is15%?
Year
Project
Project D
C
First Cost
-$40,000 -$65,000
(year 0)
Annual cost -$10,000 -$12,000
(from year1)
Salvage
$12,000 $25,000
Value
Life, Years
3
6
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