8.4 Chapter Summary

Key Concepts 

• 8.1 Net Present Value 
  • The characteristics of making decisions including decision types, monetary sources, and interest rates.
  • Making decisions through net present value.
• 8.2 Internal Rate of Return
  • Using internal rate of return to choose whether to pursue one course of action.

Glossary of Terms

• Cash Flow.  A movement of money into or out of a particular project.
• Cost of Capital. A weighted average of all of the debt and equity financing rates used to provide needed funds for a project.
• Internal Rate of Return (IRR).  The annual rate of return on the investment being made such that the net present value of all cash flows in a particular project equals zero.
• Net Present Value (NPV).  The difference in today’s dollars between all benefits and costs for any given project.

Formulas

• Symbols Used

  • [latex]NPV[/latex] = net present value
  • [latex]IRR[/latex] = internal rate of return

• Formulas Used

  • Net Present Value: [latex]NPV = \mbox{(Sum of PV of All Future Cash Flows)} − \mbox{(Initial Investment)}[/latex] or  [latex]NPV = \mbox{(Sum of PV of Cash Inflows)} − \mbox{(Sum of PV of Cash Outflows)}[/latex]

Calculator

• Cash Flow Worksheet

  • Access the cash flow function by pressing CF on the keypad.
  • Always clear the memory using 2nd CLR WORK so that any previously entered data is deleted.
  • Use the up arrow and down arrow to scroll through the various lines.
  • Strictly adhere to the cash flow sign convention when using this function and press ENTER after keying in the data.
  • To exit the window, press 2nd QUIT.
  • The various lines are summarized below:
    • CFo = any cash flow today.
    • CXX = a particular cash flow, where XX is one of a series of cash flow numbers starting with 01. You must key in cash flows in order from the first time segment to the last. You cannot skip a time segment, even if it has a value of zero, because each time segment is a placeholder on the timeline.
    • FXX = the frequency of a particular cash flow, where XX is the cash flow number. It is how many times in a row the corresponding cash flow amount occurs. This allows you to enter recurring amounts together instead of keying them in separately. By default, the calculator sets this variable to 1.

• Net Present Value

  • Use this function after you have entered all cash flows.
  • Press NPV on the keypad to access the function.
  • Use the up arrow and down arrow to scroll through the window.
  • To exit the window, press 2nd QUIT.
  • This window has two lines:
    • I = the matching periodic interest rate for the interval of each time segment.
    • NPV = the net present value. Press CPT to calculate this amount.

• Internal Rate of Return

  • Use this function after you have entered all cash flows.
  • Press IRR on the keypad to access the function.
  • Press CPT button to perform the calculation. The output is in percent format.
  • To exit the window, press 2nd QUIT.

  

_{Cash Flows 1: Net Present Value (NPV) and IRR Calculations by Joshua Emmanuel [2:52] (transcript available).}