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Investment Criteria
1. Discounting Criteria
NPV Benefit to Cost Ratio Internal Rate of Return
2. Non-Discounting Criteria
Payback Period Accounting Rate of Return
1.a. NPV
Ct NPV Initial Investment t t 1 (1 r )
Year 0 1 Cash Flows (1,000,000) 200,000
2
3 4 5
200,000
300,000 300,000 350,000
Merits of NPV
Recognizes TV of money;
rate;
This Method helps to calculate the NPVs of two
INTERNAL RATE OF RETURN (IRR) Is the rate of return that equates the NPV of a project to zero
Present Value of Inflows
=0
P
Q
-10000
-50,000
20000
75,000
100%
50%
7857
16,964
Should the project be accepted if the Ans: 14.98% required rate is 16%? Formula:
IRR Lower rate NPV at lower rate ( Higher rate Lower rate) NPV at lower rate NPV at higher rate
A project costs Rs. 81,000 and is expected to generate net cash inflows of Rs.40,000, Rs.35,000, Rs30,000 over its life of three years. Compute the BCR or PI of the project if the discounting rate is 14%. 1.02 Should the project be Ans: accepted ?
Payback period
Time period required to recover the initial
Limitations
Fails to consider the time value of
money It ignores cash flows beyond the payback period Its a measure of project recovery not Year the profitability 1 0 2 3 4 5 6 Cash flow of A -100000 50000 30000 20000 10000 10000 Cash flow of B -100000 20000 20000 40000 50000 30000 -
A project involves an initial outlay of 40,000. The cash inflow in the first second and third year from the project are 10,000, 20,000 and 20,000 respectively. Compute the pay back period. If the discount rate is 10%, compute the discounted pay back period. Ans:
2 and 6 months 2 years, 11months, 14 days
(I0 + In)/2