Premium Essay

Financial Detective

In: Business and Management

Submitted By Phe14menal
Words 494
Pages 2
To: Dr. Map
From: Phe
Date: February 16, 2013
RE: Case 18 (The Investment Detective)
Projects can be measured by inspecting cash flows alone but there are additional metrics than can be used to make the best recommendations. A brief description of each metric is provided below. * NPV: Net present value is the difference between the present value of the cash inflows and the cash outflows. If the NPV is positive a project should be accepted and if it is negative the project should be rejected. * IRR: Internal rate of return is the discount rate that results in a zero NPV for a project. * PI: Profitability index is equal to the present value of an investments future cash flows divided by its initial cost. A PI greater than one indicates that the present value of the investment’s future cash flows exceeds the cost of making the investment and the investment should be accepted. * PB: The payback period is the number of years of needed to recover the initial cash outlay required to make the investment. * EAC: The cost per year of each project.
When completing an analysis, one must be aware of the advantages and disadvantages associated with each metric. NPV has the advantage is that it measures directly the increase in value that the project is expected produce. A possible disadvantage is that it requires an understanding of the time value of money. IRR provides a rate of return metric although there can be multiple rate of returns for projects with multiple changes in the sign of their cash flows over time. PB has the advantage of being easy to understand and calculate and the disadvantage of ignoring the time value of money. PI is useful when rank ordering positive NPV projects where capital is being rationed. It has the disadvantage of not being as familiar to managers as NPV.
There are concerns raised with the validity of

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