1. Payback

2. Net Present Value

3. Internal Rate of Return

4. Profitability Index

Calculates the period of time it takes to recover early cash flows. 

Shorter paybacks are better, longer riskier.

If the payback period is less than the policy's maximun accept the project. If payback period is more, reject.

- Stops counting when we are paid back

- Ignores TVM

- Ignores Risk

- When making a low dollar investment

- As a tie breaker (choose project that gets you your money back first)

Take cash flow and cumulative cash flow to determine when money is paid back.  Roundup - rounds up the year in which money is paid back. Interpolated - Gives a more accurate idea of when paid back.

For Interpolated take number of years + (amount still needed in last year/ amount expected in last year)

- NPV is the net effect that undertaking a project is expected to have on the firm's value

If NPV > 0, then the expected return beats the required return.

If NPV < 0, then will decrease firm's value

A firm should select the NPV with the highest value to maximize shareholder wealth.

Stand alone Projects:

NPV > 0, accept

NPV < 0, reject

NPV = 0 ?

Mutually Exclusive Projects:

NPV(a) > NPV(b) choose A over B

Use Cash Flow Registers

CF0= Amount put in +/-

CF1 = amount expected year 1

CF2 = amount expected year 2

and so on...

I= Cost of Captial rate

Compute NPV

- A project's IRR is the return it generates on the investment of its cash outflows

- It is a yield measure (%) - NPV is a dollar measure

- Estimates the expected return

- IRR is the interest rate that makes a project's NPV zero

Stand alone projects:

- If IRR > cost of capital (or k) accept

If IRR < cost of capital  reject

***You MUST know both the expected and required return in order to make a decision***

Mutually Exclusive Projects:

IRR(a) > IRR(b) choose project A over project B

BUT if required return is more than either A or B, reject both

Use the cash flow registers.

CF0 = Amount out

CF1 and so on = amount expected each year

CPT IRR

outflow/annunity

- Is a variation of the NPV method

- It is a ratio of the present value of a project's inflows to the present value of a project's outflows

- Indicates value per dollar invested

- PI must be greater than 1

- higher PI means more value

PI = Present Value of inflows/ present value of outflows

Stand Alone Projects:

- If PI > 1 accept

- If PI < 1, reject

Mutually exclusive Projects:

PI(a) > PI(b) choose A over B

First, calculate NPV using cash flow register

CF0 = 0 (we can ignore for this one)

C01 = amount expected year 1

C02= amount expected year 2

and so on...

NPV, I= cost of capital rate ENT down, NPV CPT

Then, once you have your NPV...

PI = NPV/ amount of initial outflow

- Replacement chain method

- Equivalent Annual Annuity Method

ALWAYS CALCULATE EAA FIRST!!!!

First, use Cash Flow registers to compute NPV for both the short and long term projects.

Then, calc. EAA by taking the NPV as PV and computing PMT using TVM calculation for both short and long term projects

Then, take short term project with and compute PV but use the "N" as the number of years in the longer term project. Compare the PV amount to the NPV you originally got for the Longer term NPV.

Yes, because:

- Expected returns are estimates

- WACC is estimate

- Money is only one resource

- Keep or maintain a cash reserve