NPV, IRR, and Payback: Capital Budgeting
Core capital-budgeting metrics — NPV decision rule, IRR pitfalls, and payback limitations.
12 cards· by GuruOwl
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Try it- 01What is Net Present Value (NPV)?The present value of cash inflows minus the present value of cash outflows, discounted at the required rate of return.npv
- 02What is the NPV decision rule for independent projects?Accept if NPV > 0 (creates value); reject if NPV < 0.npv
- 03What is Internal Rate of Return (IRR)?The discount rate that sets a project’s NPV equal to zero.irr
- 04What is the IRR decision rule (conventional independent project)?Accept if IRR > required return (cost of capital); reject if IRR < required return.irr
- 05Why can IRR be misleading with mutually exclusive projects?IRR ignores scale and timing differences; NPV is preferred for ranking value creation.pitfalls
- 06What is the multiple-IRR problem?Nonconventional cash flows (sign changes more than once) can produce multiple IRRs, making the metric ambiguous.pitfalls
- 07What is the payback period?Time required to recover the initial investment from project cash flows (often undiscounted).payback
- 08What is a key weakness of the simple payback method?Ignores time value of money and cash flows after payback; arbitrary cutoff.payback
- 09What is discounted payback?Payback computed using discounted cash flows — accounts for time value but still ignores post-payback cash flows.payback
- 10If two projects are mutually exclusive and conflict on IRR vs NPV, which should you generally follow?NPV — it measures absolute value added at the cost of capital.decision
- 11What does a higher discount rate do to NPV of a normal project?Lowers NPV (future cash flows are discounted more heavily).npv
- 12What is the profitability index (PI)?PV of future cash flows / initial investment (or 1 + NPV/Investment) — useful under capital rationing.pi