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Time Value of Money

1. Describe the following project evaluation processes: Payback, NPV, PI, IRR. Is any one evaluation process better the others? Why?

2. Group "A" will use 4% factors
A) Calculate the Future value of $400 compounded annually for 5 years.
B) Calculate the Future value of $400 compounded semi-annually for 5 years.
C) Calculate the Present value of $500 received in 10 years. (annual discounting)
D) Calculate the Future value of a $1,000 per year annuity for 10 years. (annual payments)

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1. Describe the following project evaluation processes: Payback, NPV, PI, IRR. Is any one evaluation process better the others? Why?

Payback
Payback time or payback period is the time it will take to recoup, in the form of cash inflows from operations, the initial dollars invested in a project.
The payback period, PP, is the length of time it takes to recover the initial investment of the project. To apply the payback period criterion, it is necessary for management to establish a maximum acceptable payback value PP*. In practice, PP* is usually between 2 and 4 years. In determining whether to accept or reject a particular project, the payback period decision rule is:

Accept if PP < PP*
Reject if PP > PP*
Indifferent where PP = PP*
For mutually exclusive alternatives accept the project with the lowest PP if PP<PP*

The problems with the payback method are that:
It ignores the time value of money;
The payback period does not indicate whether the project should be accepted or rejected. For example, we don't know whether 4.07 years is a good payback period, or not
It ignores the cash flows that occur after the payback period;Cash flows that occur after the end of the payback time are ignored in the calculation of payback period. Yet, these latter cash flows may be significant in making the decision.
It ignores the scale of ...

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