unit 6

• A decision is good for the firm if it increases it's value by providing benefits whose value exceeds the costs
• What is discounted cash flow?

  a financial tool used to evaluate investment opportunities
• Measurements that use DCF are NET present value and internal rate of return (IRR)
• Payback rule also helps evaluate an invertment
• Financial decisions have costs and benefits that occur at different points in time but these are not directly comparable
• Interest rate is the rate at which money is lent or borrowed over a given period
• investment rate defines how we convert cash flows across time
• Interest rate factor = 1 + r (r=%)
• present value is the value of a cost/benefit in terms of cash today
• In general, a dollar received today is worth more than a dollar received in 1 year
• Net present value is the difference between present value of benefits and present value of costs
• NPV = PV(benefits) - PV(costs)
• Good projects are those in which the PV of the benefits exceeds the PV of the cost
• The NPV decision rule implies that we should accept positive projects because it is equivalent to receiving their NVP in cash today
• The NVP decision rule implies that we should reject negative NVP projects because accepting them would reduce the value of the firm
• Discount rate is the rate used to determine the present value of future cashflow
• Internal rate of return (IRR) is the rate at which the PV of benefits exactly compensates the costs
• Payback period is the amount of time it takes to recover the cost of an investment
• Payback period is not a measure of profitability, it is a measure of risk
• An opportunity that pays back its initial investment quickly is a good idea
• What are the limits of the payback rule?

  it ignores the time value of money, it ignores the cashflows after the payback period and it lacks a decision criteria grounded in economics
• What are 3 characteristics of a quality cashflow forecast?

  all benefits, expenses and investments that will change as a result of the decision should be included, it should provide a maximum of 5 years worth of inflows and forecasts should reflect current product prices and operating costs