Often capital expenditure projects do not produce measure revenues. Therefore, the economic value or investment worth of such projects is measured in terms of cost savings. For competing projects, the project that produces the largest net cash-cost saving is to be preferred (absent any other compelling factors) because it will produce higher profits than the other projects.
We will now return to the primary problem of computing the economic value or investment worth of a proposed capital expenditure using the two DCF methods---net present value and internal rate of return.
Net Present s Value Method Used to Rank Investments
The DCF net present value method compares the present value of the net cash inflows with the present with the present value of the initial net cash cost of a capital expenditure project; the dollar difference these two present value amounts is called net present value. The net cash inflows (I.e., cash inflows minus cash outflows) are discounted to present value by using a “target” or minimum rate of return (I.e., an interest rate.) Therefore, this method requires determination of three items for a project---initial cash outflow, future net cash inflows, and a target rate of return.
If the computed dollar difference between the initial net cash investment (the present value cash paid for the investment) and the computed present value of the net cash inflows from the investment is favorable (i.e., positive) to the net cash inflows, the project will earn more than the target rate of return. If the difference is not favorable to the net cash inflows, the projects will not earn the target rate of return. When ranking competing projects, the one with the highest net present value (in dollars) is ranked first (absent any other compelling factors). The present value method is illustrated in Exhibit 11-5. Notice
Often capital expenditure projects do not produce measure revenues. Therefore, the economic value or investment worth of such projects is measured in terms of cost savings. For competing projects, the project that produces the largest net cash-cost saving is to be preferred (absent any other compelling factors) because it will produce higher profits than the other projects. We will now return to the primary problem of computing the economic value or investment worth of a proposed capital expenditure using the two DCF methods---net present value and internal rate of return.Net Present s Value Method Used to Rank InvestmentsThe DCF net present value method compares the present value of the net cash inflows with the present with the present value of the initial net cash cost of a capital expenditure project; the dollar difference these two present value amounts is called net present value. The net cash inflows (I.e., cash inflows minus cash outflows) are discounted to present value by using a “target” or minimum rate of return (I.e., an interest rate.) Therefore, this method requires determination of three items for a project---initial cash outflow, future net cash inflows, and a target rate of return. If the computed dollar difference between the initial net cash investment (the present value cash paid for the investment) and the computed present value of the net cash inflows from the investment is favorable (i.e., positive) to the net cash inflows, the project will earn more than the target rate of return. If the difference is not favorable to the net cash inflows, the projects will not earn the target rate of return. When ranking competing projects, the one with the highest net present value (in dollars) is ranked first (absent any other compelling factors). The present value method is illustrated in Exhibit 11-5. Notice
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Often capital expenditure projects do not produce measure revenues. Therefore, the economic value or investment worth of such projects is measured in terms of cost savings. For competing projects, the project that produces the largest net cash-cost saving is to be preferred (absent any other compelling factors) because it will produce higher profits than the other projects.
We will now return to the primary problem of computing the economic value or investment worth of a proposed capital expenditure using the two DCF methods---net present value and internal rate of return.
Net Present s Value Method Used to Rank Investments
The DCF net present value method compares the present value of the net cash inflows with the present with the present value of the initial net cash cost of a capital expenditure project; the dollar difference these two present value amounts is called net present value. The net cash inflows (I.e., cash inflows minus cash outflows) are discounted to present value by using a “target” or minimum rate of return (I.e., an interest rate.) Therefore, this method requires determination of three items for a project---initial cash outflow, future net cash inflows, and a target rate of return.
If the computed dollar difference between the initial net cash investment (the present value cash paid for the investment) and the computed present value of the net cash inflows from the investment is favorable (i.e., positive) to the net cash inflows, the project will earn more than the target rate of return. If the difference is not favorable to the net cash inflows, the projects will not earn the target rate of return. When ranking competing projects, the one with the highest net present value (in dollars) is ranked first (absent any other compelling factors). The present value method is illustrated in Exhibit 11-5. Notice
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