Fins1613 Notes

FINS1613 Business and Finance Quiz 2 Notes: Capital Budgeting

Mutually Exclusive Projects: accepting one will mean the rejection of every other one, we usually accept the higher positive NPV. We can also reject all projects if they are all negative

Independent Projects: each investment can be either rejected or accepted and they do not affect each other

Net Present Value (NPV): the difference between an investment’s market value and its cost of initial investment

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Discounted Cash Flow Valuation (DCF): valuation calculating the present value of a future cash flow to determine its value today

Decision rule for NPV: accept an investment if NPV>0, reject if NPVrequired rate of return, rejected otherwise

NPV decision rule and IRR decision rule can be the same if the 2 conditions are met: First, they must both have the first cash flow to be negative (conventional). Second, the project must be an independent project.

Disadvantages of IRR: multiple rates of return (the possibility that more than one discount rate makes the NPV of an investment zero), can be not conventional, multiple negative cash flows at first

Note: If project is mutually exclusive (ie. accept one only) ( depending on whether the IRR is less than or greater than the “crossover rate”, this is what will determine the higher NPV

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The Modified Internal Rate of Return (MIRR): a variation on the IRR, it differs such that MIRR assumes that cash flows are re-invested at the discount rate and MIRR will not generate multiple results

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where TV is the Terminal Value (future value formula, what it is worth at the very end)

|Advantages: |Disadvantages: |

|Simple decision rule and easy to understand |Calculation can be complicated |

|Does not generate multiple results in the presence of non |Does not account for...