NPV and Investment Evaluation Techniques

A set of flashcards summarizing key terms and concepts related to Net Present Value (NPV) and methods for evaluating investments.

NPV

The difference between present value of inflows and outflows.

Payback Period

The time required to recover the initial investment.

IRR

The discount rate that makes NPV equal to zero.

Profitability Index (PI)

The benefit-cost ratio calculated as present value of inflows divided by initial cost.

Positive NPV

Indicates a project creates value.

Effect of Increased Required Return on NPV

NPV decreases.

IRR Equals Required Return

When IRR equals the required return, NPV is zero.

Reject Project Criteria

Reject if NPV is less than zero or PI is less than one.

Best Method for Value Creation

NPV method.

Best Use for Payback Method

Low-cost, short-term projects.

Bias of Payback Method

Biased toward short-term projects.

Limitations of Payback Method

It ignores later cash flows.

Positive NPV When IRR is Greater Than Required Return

NPV is positive.

Best Method for Mutually Exclusive Projects

NPV method should be used.

Meaning of PI Equals 1

NPV equals zero, indicating break-even.

NPV When Return Equals Required Return

NPV is zero.

Key Flaw of Payback Method

Ignores time value of money.