Npv

Capital Budgeting – the process of choosing the bests investment projects.

Because they are rarely used in practice and inefficient techniques, we will not cover Payback, Discounted Payback and Accounting Rate of Return.

NPV - Net Present Value - Present value of a project's cash flows

Opportunity Cost of Capital - The appropriate discount rate

- The rate of return given up by investing in a project

- The risk-adjusted rate of return

- The rate of return investors could earn on an investment of equal risk

How to Make a Capital Budgeting Decision

1. Forecast the project's cash flows

2. Determine the opportunity cost of capital

3. Discount all cash flows to time zero at the opportunity cost of capital

4. Net out all the time zero cash flows - that's your NPV

5. If NPV > 0, accept the project

If NPV < 0, reject the project

Rule of Thumb: Accept all positive NPV projects

Example:

Cost: $100,000