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Market Essay

782 words - 4 pages

Business Finance
Assignment 1

Name: Law Chui Yin Joyce
Student ID: 12030017D
Tutor: Miss Anson Wong
Tutorial Session: Wednesday 11:30-12:20

Question 1

Net Present Value (NPV) is the difference between the present value of future cash flows and the present value of the cost of the investment. It measures the surplus or deficit of cash flows, in terms of present values. NPV considers all cash flows. It can give a reliable decision to investors. It can also rank mutually exclusive projects. NPV applies a proper discount rate, which means it includes the time value of money in consideration. NPV can give clear and rational acceptance criteria, since it states that investors ...view middle of the document...

It not only measures how long a project takes for the initial cost to be paid back, but also applies a proper discount rate. It means that discount payback period takes time value of money into consideration. So, discounted payback period can be applied in more scenario than payback period.

Internal Rate of Return (IRR) is the required return that results in a zero NVP when it is used in the discount rate. Based on IRR, an investment is acceptable if the IRR exceeds the required return. IRR is closely related to NPV, often leading to identical decisions. It is also easy to understand and communicate. However, it may result in multiple or no IRR with nonconventional cash flows. It may also lead to incorrect decision in comparisons of mutually exclusive investments. It does not distinguish whether the project is investing or borrowing too.

Profitability Index (PI) is an index that identifies the relationship between costs and benefits of a project. It is the ratio of the present value of future cash flows divided by the amount of the initial investment. PI has an obvious acceptance criteria, accept the project if PI is greater than 1. It is closely related to NPV and generally leading to identical decisions. It is also easy to understand. Moreover, it may be useful when available investment funds are limited. However, it may lead to incorrect...

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