Why are net present value and internal rate of return considered discounted cash flow methods?
NPV and IRR are called the discounted cash flow method as they are based on the time value of money and discount the future cash flow to the present value.
Discounted cash flow is based on the time value of money. It is the amount that represents the present value of a future amount.
Time value of money states that the value of money today would not be equal to the value of money tomorrow due to the factor of interest payment.
Thus the discounted cash flow equates the future cash flow to the present value by discounting the interest factor.
streams and present cash outflow. Under this method,future cash flows are discounted to the present value.
The internal rate of return is the rate at which the present value of all future cash flows equates with the present value of cash outflows.
Thus as discussed, these two methods use the time value of money concepts and discount the future cash flow to the present value by considering the interest rate factor; these methods are called the discounted cash flow method.
Henry Co. is considering acquiring a manufacturing plant. The purchase price is $1,200,000. The owners believe the plant will generate net cash inflows of $325,000 annually. It will have to be replaced in six years. Use the payback method to determine whether Henry should purchase this plant. Round to one decimal place.
Refer to the Hunter Valley Snow Park Lodge expansion project in Short Exercise S26-4 and your calculations in Short Exercises S26-5 and S26-6. Assume the expansion has zero residual value.
1. Will the payback change? Explain your answer. Recalculate the payback if it changes. Round to one decimal place.
2. Will the project’s ARR change? Explain your answer. Recalculate ARR if it changes. Round to two decimal places.
3. Assume Hunter Valley screens its potential capital investments using the following decision criteria:
Maximum payback period
Maximum accounting rate of return
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