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Discounted cash flow valuation methods

A) Is one method better than another?

B) Why or why not, please explain.

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The investment decisions of a firm are generally known as the capital budgeting, or capital expenditure decisions. Some concepts are better than others when it comes to reliability but all provide enough information to get the general scope of the investment. The five procedures that provide useful information are the Net present Value (NPV), the Payback Rule, the Average Accounting Return (AAR), the Internal Rate of Return (IRR), and the Profitability Index (PI). These procedures will help rank the projects from the greatest investment to the worst.

The discounted cash flow methods are:
1) NPV
2) PI
3) IRR

Profitability Index (PI) can be calculated by dividing the present value of an investment's future cash flow divided by its initial cost. The PI is directly correlated with the NPV in that if the NPV is positive then the PI will be over 1.00, and a negative NPV will produce a PI of less than 1.00. This procedure is good to evaluate these Projects because it is so similar to the NPV, it is easy to understand, and it is useful when available investment funds are limited. The only downfall to this calculation is it may lead to an incorrect decision of mutually exclusive investments.

NPV is defined as the difference between an investment's market value and its cost. It is only a good investment if ...

Solution Summary

This explains the discounted cash flow valuation methods such as Net present value (NPV), Profitability Index ( PI), Internal rate of return (IRR)

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