c10: evaluating cash flows

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Created by
noah

Cards (18)

  • modified internal rate of return (MIRR) is the discount rate that causes the PV of a project’s terminal value (TV) to equal the PV of costs
  • a project’s terminal value (TV) is found by compounding inflows at WACC
  • MIRR assumes cash inflows are reinvested at WACC, which is reasonable. rule is that we Accept the project if MIRR > rWACC
  • For 2 mutually exclusive projects of equal size and the same life, NPV and MIRR will always lead to the same decision
  • The profitability index (PI) is the present value of future cash flows divided by the initial cost. it's the scale version of NPV. measures the “bang for the buck"
  • with pi, To accept a project, PI > 1. when PI > 1 its equivalent to NPV > 0
  • pi = pv of project's cf / inital cost
  • the Payback period is the number of years required to recover a project’s cost, or how long it takes to get the business’s money back
  • firms establish a benchmark payback period; projects whose payback exceeds this benchmark are rejected
  • strengths of the payback method include:
    • Indicates a project’s risk and liquidity
    • Easy to calculate and understand
  • Weaknesses of the payback method:
    • Ignores the time value of money (tvm)
    • Ignores CFs occurring after the payback period
    • Not necessarily related to investor wealth
  • the discounted payback period is Defined as the number of years required to recover the investment from discounted net cash flows
  • Projects with shorter payback periods are preferred to those with longer ones
  • As an indicator of how long funds are to be tied up in a project, payback methods measure the project’s liquidity and risk
  • NPV is the single most important method, directly measuring the dollar benefit of the project to shareholders. IRR is ranked second
  • IRR, MIRR, and PI all contain information about a project’s “safety margin. MIRR avoids the multiple IRR problem and PI indicates the project’s risk
  • PB and discounted PB indicate both the risk and the liquidity.
  • equivalent annual annuity (eaa) measurement should only be used for unequal life projects