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NPV Project Investments

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NPV or IRR investment decision process, why include manager intuition?

$1 Million NPV project, what does this mean?

For what kinds of investments would terminal value account for a substantial fraction of the total project NPV, and for what kinds of investments would terminal value be relatively unimportant?

Suppose an analyst makes a mistake and calculates the NPV or an investment project by discounting the project's contribution to net income each year rather than by discounting its cash flow. Would you expect the NPV based on net income to be higher or lower than the NPV calculated using cash flows?

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Solution Preview

NPV and IRR are capital budgeting techniques used as bases in making capital budgeting decisions. They are important tools used by the management that provide criteria that will be used to decide on whether an investment proposal must be pursued or not.

The Net Present Value and IRR rely heavily on estimates of future cash flows that would result from the implementation of a project. These cash flows are yet to be realized in the future. As such, the management must use the most effective forecasting technique, making use of the most realistic assumptions possible, in order to arrive at the most objective estimates of future results of investments.

Aside from relying heavily on estimates of future cash flows, NPV and IRR methods need to determine the discount rates that will be used in converting the future cash flows into their present values. The discount rates may be the cost of borrowing or cost of capital or the cut-off rate set by the management.

In the process of determining the future cash flows, management intuition already comes in. The manager's intuition applies in forecasting possible future events that may affect cash flow figures. While forecasting methods are quanititative in nature, the bases such as the hint of turnout of possible events will still rely on the manager's or analyst's ...

Solution Summary

NPV project investments are examined. What kinds of investments would terminal value accounts for a substantial fractions of the total project NPV is determined.

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