Term
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Definition
| The process of planning significant investments in projects that have long term implications, such as the purchase of new equipment, or the introduction of a new product. Methods: Net present Value (NPV) and Internal Rate of Return (IRR) |
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Term
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Definition
Method of capital budgeting. Compute the present value of the cash inflows minus the present value of the cash outflows. The difference is the Net Present Value of the project.
-If NPV= zero, the project yields minimum rate of return.
-If NPV > Zero, the project yields a rate of return greater than the minumum (favorable)
-I NPV < Zero, project yields a rate of return lower than the minimum (would not undertake project) |
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Term
| Internal Rate of Return (IRR) |
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Definition
Method of capital budgeting. Find the discount rate at which the NPV of the project = $0. This is the Internal Rate of Return or "Actual Return". Then compare the IRR to the required rate of return.
-If IRR >/= Required rate or return, then accept
-If IRR < Required rate of return, then reject |
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Term
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Definition
1) Find factor of IRR= Investment Required/Annual Net Cash Flow.
2) Look up factor of IRR in present value of annuity table using appropriate number of periods. |
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Term
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Definition
When ranking investment projects, obviously the higher the IRR and NPV the better. Profitability index is another measurement.
-NPV of a project/Investment Required
-Shows which project gives you more "bang" for your buck |
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