BU393 Lecture Notes - Lecture 2: Net Present Value, Cash Flow, Capital Budgeting
Document Summary
Capital budgeting process of deciding which long term investments or projects a firm will acquire. 5 steps a firm should follow when deciding: identification of opportunities, evaluation of opportunities, selection, implementation, post audit. Payback period (pb) number of years required to recapture initial investment, initial investment/annual cash flow. Net present value (npv) the present value of all cash flows, pv cash inflows pv cash outflows. Profitability index (pi) the ratio of the present value of the cash inflows to outflows, pv inflows/pv outflows, Internal rate of return (irr) the interest rate that sets the present value of cash inflows equal to the present value of outflows. Modified internal rate of return (mirr) the interest rate that sets the present values of the outflows equal to the future values of the inflows, computed at the firm"s cost of capital. Easiest to compute but the worst evaluation method. Simply the number of years it takes to recover the initial investment.
