Investment Decision Criteria Overview

An investment is considered worthwhile when the present value of its future cash flows exceeds the initial investment cost.

The net present value (NPV) is the difference between the present value of future cash inflows and the initial investment cost. A positive NPV indicates profitability.

The internal rate of return (IRR) is the discount rate that makes the NPV of an investment equal to zero. It represents the expected annual return on an investment.

An investment is considered acceptable when its internal rate of return (IRR) exceeds the desired rate of return.

Project size, timing of cash flows, and the reinvestment rate can all lead to discrepancies between IRR and NPV. However, projects with perpetual cash flows do not cause such discrepancies.

While IRR is useful for comparing investments, it can be unreliable when investments have varying holding periods. NPV, on the other hand, is a more reliable measure in such cases.

Present value is the value of future cash flows discounted back to today's value using a specified discount rate.

When the present value is greater than zero, it means the project is expected to yield a rate of return higher than the discount rate used.

Present value is a key concept in financial analysis and is used for decision making in various financial situations.

The discount rate used to calculate present value represents the opportunity cost of capital. It's the return that could be earned on an alternative investment with similar risk.

The internal rate of return (IRR) is the discount rate that makes the net present value (NPV) of all cash flows from a project equal to zero. In other words, it's the rate at which the investment is expected to yield a return.

The IRR assumes that all future cash flows from the project will be reinvested at the same rate as the IRR.

The IRR method can sometimes lead to different investment decisions compared to the net present value (NPV) method. This can happen when a project has both positive and negative cash flows.

The NPV is calculated by subtracting the initial investment from the present value of all future cash flows.

NPV is equal to the present value of expected cash flows minus the initial cash outlay.

When comparing mutually exclusive projects with different life spans, the project with a longer lifespan will likely have a higher NPV. This is because the longer timeframe allows for more cash flows to be discounted back to present value.

The IRR will exceed the discount rate used to calculate the net present value (NPV) only when the NPV is greater than zero. This indicates that the project is expected to generate a return above the cost of capital.

The internal rate of return (IRR) equation incorporates the initial cash outflow and inflow, and future cash outflows and inflows. This includes the time value of money and determines the return rate of the investment.

Project S is the better investment choice as it yields the highest net present value.

The appropriate discount rate is the opportunity cost of capital, which is the rate of return on the next best alternative investment opportunity. It represents the minimum return required for an investment to be worthwhile.