MANAGERIAL FINANCE (FIN
301) NOTES FOR FINAL
EXAM LABENESE AMERICAN
UNIVERSITY
, Managerial Finance Final Exam Notes
Net Present Value and other investment criteria
In this chapter we are evaluating our capital budgeting, in other words we are deciding on
whether to take on investments depending on several measures that we are going to compute.
● The Net Present Value NPV
The NPV measures the increase in the firm value, which is also the increase in
shareholders’ wealth.
To calculate: NPV= the present value of future cash inflows - present value of outflows.
If NPV is positive, we accept the project.
NPV:
1. accounts for the time value of money
2. Accounts for the risk of cashflows
3. Provides an indication for the increase in value
Thus, it is considered as a primary decision rule.
● PayBack Period
Tells us when the initial cost will be paid back (in a nominal sense)
We accept the project if the payback period is less than the preset limit.
It does NOT account for the time value of money, nor the risk of cash flows, and does not
give us an indication of an increase in value.
Thus, it is not considered as a primary decision rule.
● Discounted PayBack Period
We compute the present value of each cash flow and then determine how long it takes to
pay back on a discounted basis.
Since, cashflows are discounted, this decision rule accounts for the time value of money and for
the risk of cashflows.
However it does not give an indication about the increase in value. Since this rule does
301) NOTES FOR FINAL
EXAM LABENESE AMERICAN
UNIVERSITY
, Managerial Finance Final Exam Notes
Net Present Value and other investment criteria
In this chapter we are evaluating our capital budgeting, in other words we are deciding on
whether to take on investments depending on several measures that we are going to compute.
● The Net Present Value NPV
The NPV measures the increase in the firm value, which is also the increase in
shareholders’ wealth.
To calculate: NPV= the present value of future cash inflows - present value of outflows.
If NPV is positive, we accept the project.
NPV:
1. accounts for the time value of money
2. Accounts for the risk of cashflows
3. Provides an indication for the increase in value
Thus, it is considered as a primary decision rule.
● PayBack Period
Tells us when the initial cost will be paid back (in a nominal sense)
We accept the project if the payback period is less than the preset limit.
It does NOT account for the time value of money, nor the risk of cash flows, and does not
give us an indication of an increase in value.
Thus, it is not considered as a primary decision rule.
● Discounted PayBack Period
We compute the present value of each cash flow and then determine how long it takes to
pay back on a discounted basis.
Since, cashflows are discounted, this decision rule accounts for the time value of money and for
the risk of cashflows.
However it does not give an indication about the increase in value. Since this rule does
