Net Present Value and Other Investment Criteria

What is the Criterion?

Maximizing Firm Value

)1(

0

N

tt

t

r

CFPV

What is the Criterion?

• Net Present Value

N

tt

t

r

CFCFNPV

10

)1(

What is the Criterion?

• Profitability Index

0

1)1/(

CF

rCFPI

N

t

tt

What is the Criterion?

• Internal Rate of Return

N

tt

t

IRR

CFCF

NPVIRR

10

)1(

0

What is the Criterion?

• Pay Back

• Average Accounting Rate of Return

Np

ttCFCF

10

N

t t

t

BookEquity

NetIncome

NAAR

1

1

Problem 17

Year Cash Flow (A) Cash Flow (B)

0 -$180,000 -$18,000

1 10,000 10,000

2 25,000 5,000

3 25,000 3,000

4 380,000 20,000

Problem 17

PaybackPeriod Cum CF(A) Cum CF(B)

1 10000 10000

2 35000 15000

3 60000 18000

4 440000 38000

Discounted Pay BackDiscounted Discounted

Time Cum CF (A) Cum CF (B)

1 8696 8696

2 27599 12476

3 44037 14449

4 261303 25884

Problem 17

NPV, Profitability Index, and IRR

• Discount Rate NPV (A) NPV (B)

• 0.00% $ 260,000 $ 20,000

• 5.00% $ 186,422 $ 15,105

• 10.00% $ 128,080 $ 11,137

• 15.00% $ 81,303 $ 7,884

• 20.00% $ 43,418 $ 5,187

• 25.00% $ 12,448 $ 2,928

• 30.00% $ (13,087) $ 1,019

• 35.00% $ (34,308) $ (608)

Profitability Index Project A Project B

@ 15%

IRR Project A Project B

Problem 17

NPV Profiles for Projects A & B

$(50,000)

$-

$50,000

$100,000

$150,000

$200,000

$250,000

$300,000

0.00% 5.00% 10.00% 15.00% 20.00% 25.00% 30.00% 35.00% 40.00%

Discount Rates

NP

Vs Project A

Project B