# AUBURN FINC 3610 - Investment Criteria (11 pages)

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## Investment Criteria

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## Investment Criteria

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Pages:
11
School:
Auburn University
Course:
Finc 3610 - PRINCIPLES OF BUSINESS FINANCE (3)
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Investment Criteria Investment Criteria 204 Net Present Value NPV What NPV is a measure of how much value is created or added today by undertaking an investment the difference between the investment investment ss market value and its cost How Estimate future cash flows Calculate the present value of those cash flows minus the initial cost 205 NPV Example You plan to buy a machine that will cost 2 000 today and produce cash flows of 1 500 in each of the next two years The salvage value will be zero zero The cost of capital is 15 percent Should you buy the machine 206 FINC 3610 Yost Investment Criteria Net Present Value NPV The Rule An investment should be accepted if the net present value is positive and rejected if it is negative Assumes cash flows are reinvested at Pros 1 2 Cons 1 2 207 Internal Rate of Return IRR What The internal rate of return is the discount rate that makes the net present value of a project equal to zero How Set NPV equal to zero and solve for r Calculating IRR is identical to calculating the yield to maturity on bonds 208 IRR Example You plan to buy a machine that will cost 2 000 today and produce cash flows of 1 500 in each of the next two years The salvage value will be zero zero The cost of capital is 15 percent Should you buy the machine 209 FINC 3610 Yost Investment Criteria Internal Rate of Return IRR The Rule An investment is acceptable if the IRR exceeds the required rate of return It should be rejected otherwise Assumes cash flows are reinvested at Pros Pros 1 2 Cons 1 2 210 Net Present Value Profile What is it What information does it provide 1 2 3 4 211 Internal Rate of Return IRR BEWARE Nonconventional Cash flows Example Assume you are considering a project with the followingg cash flows Year Cash Flows 0 252 1 1 431 2 3 035 3 2 850 4 1 000 212 FINC 3610 Yost Investment Criteria Internal Rate of Return IRR Calculate the NPV at 25 00 NPV at 33 33 NPV at 42 86 NPV at 66 67 NPV What s the IRR 213 Internal Rate of Return IRR BEWARE

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