ROI, NPV, IRR: the return on an investment
Four decision criteria on a stream of cash flows: return on investment, payback period, net present value, internal rate of return; their computation, decision rule and disagreements.
- 21 cards
- 5 topics
- Free
The outline, topic by topic
Each topic is weighted the way the exam weighs it.
- Concepts
- Questions
- The numbers
- The curves
- Scenarios
A few cards from the deck
Cash flow: what is it?
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Money actually received or paid out at a given date, negative when paying, positive when receiving.
Investment criteria apply to cash flows, not accounting charges: a depreciation charge is not a cash flow, it takes no euro out of the till.
A project costs €10,000 and returns €4,000 at the end of each of the next 3 years. At 10%, what do you conclude?
- NPV ≈ −€53: rejected
- NPV = +€2,000: the project is accepted
- NPV ≈ +€53: the project is accepted
- NPV = 0: we are indifferent
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NPV ≈ −€53: rejected
The discounted €4,000s are worth 3,636 + 3,306 + 3,005 = €9,947, which is €53 less than the outlay. The raw sum (€12,000) would give +€2,000: that is forgetting to discount.
NPV = −investment + sum of the … flows; the project is accepted if it is ….
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NPV = −investment + sum of the discounted flows; the project is accepted if it is positive.
A zero NPV means the project earns exactly the required rate: it neither creates nor destroys value, and its IRR equals the discount rate.
Return on investment: what is it?
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The ratio between a project's net gain (gains minus cost) and the sum invested, expressed as a percentage.
ROI = (gains − investment) ÷ investment. It says nothing about timing: 100% in 2 years and 100% in 20 years give the same ROI.