Chapter 9 pt 2

The key to the effectiveness of this measure is that the discounting process automatically recognizes the opportunity cost of capital. An NPV of zero means the project just earns its opportunity cost rate. A positive NPV indicates that the project has positive financial value after opportunity costs are considered.

An NPV of --- means the project just earns its opportunity cost rate.

a -------- NPV indicates that the project has positive financial value after opportunity costs are considered.

Rate of Return (Cont.) In capital investment analyses, the rate of return often is called internal rate of return (IRR). In essence, it is the percentage return expected on the investment. To interpret the rate of return, it must be compared to the opportunity cost of capital. In this case 10% versus 8%.

Rate of ReturN it is the percentage return expected on the investment. EXPECTED

intra year compounding When compounding occurs intra-year, the following occurs. Interest is earned on interest during the year (more frequently). The future value of an investment is larger than under annual compounding. The present value of an investment is smaller than under annual compounding.

EAR is the annual rate which causes the PV to grow to the same FV as under intra-year compounding.

The EAR Formula EAR = 1 + - 1.0

nvestment Returns The financial performance of an investment is measured by its return. Time value analysis is used to calculate investment returns (ROI). Returns can be measured either in dollar terms or in rate of return terms. Assume that a hospital is evaluating a new MRI. The project’s expected cash flows are given on the next slide.

Amortization schedule is a table that breaks down the fixed payment of an amortized loan into its principal and Interest components.