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Origination of proposals
b)
Project screening
c)
d)
b)
c)
Depreciation
Opportunity Costs
These are the costs incurred or revenues lost from diverting existing resources
from their best use.
Example
Payback is the amount of time it takes for cash inflows = cash outflows.
Payback Example
Project P pays back in year 3 (about one quarter of the way through year 3).
Project Q pays back half way through year 2. Using payback alone to judge
capital investments, project Q would be preferred.
However the returns from project P over its life are much higher than the
returns from project Q. Project P will earn total profits before depreciation of
$140,000 on an investment of $60,000. Project Q will earn total profits before
depreciation of only $25,000 on an investment of $60,000.
Discounting starts with the future value, and converts a future value to a present
value. Discounting tells us how much an investment will be worth in todays terms. This
method can be used to compare two investments with different durations.
Question
Spender expects the cash inflow from an investment to be $40,000 after 2
years and another $30,000 after 3 years. Its target rate of return is 12%.
Calculate the present value of these future returns, and explain what this
present value signifies.
Net present value or NPV is the value obtained by discounting all cash
outflows and inflows of a capital investment project by a chosen target rate
of return or cost of capital.
Annuity Factor
IRR - Method
IRR Question
The main advantage of the IRR method is that the information it provides is
more easily understood by managers, especially non-financial managers