tailieunhanh - Lecture Quantitative investment analysis: Chapter 2 – CFA Institute

Chapter 2 – Discounted cash flow applications. This chapter calculate and interpret the net present value (NPV) and the internal rate of return (IRR) of an investment, contrast the NPV rule to the IRR rule, calculate the money-weighted and time-weighted rates of return of a portfolio,. | Discounted Cash Flow applications 1 Net present value (NPV) Net present value is the sum of the present values of all the positive cash flows minus the sum of the present values of all the negative cash flows. Interpretation: When the discount rate applied is an appropriate hurdle rate, it measures the contribution of the project to shareholder wealth. Decision rule: Accept positive NPV projects they increase shareholder wealth. 2 t = 0 t = 1 t = 2 t = 0 t = 2 t = 4 Initial Outlay0 NPV0 = ? r = req’d return t = 4 t = 3 t = 1 t = 3 CF1 CF2 –CF3 CF4 LOS: Calculate and interpret the net present value (NPV) and the internal rate of return (IRR) of an investment. Pages 40–41 The discount rate is most often going to be the firm’s weighted average cost of capital, but it doesn’t have to be. That will only be the case when the project has a level of risk similar to that of the existing company. The discount rate should be a rate that is commensurate to the level of risk the project creates | Discounted Cash Flow applications 1 Net present value (NPV) Net present value is the sum of the present values of all the positive cash flows minus the sum of the present values of all the negative cash flows. Interpretation: When the discount rate applied is an appropriate hurdle rate, it measures the contribution of the project to shareholder wealth. Decision rule: Accept positive NPV projects they increase shareholder wealth. 2 t = 0 t = 1 t = 2 t = 0 t = 2 t = 4 Initial Outlay0 NPV0 = ? r = req’d return t = 4 t = 3 t = 1 t = 3 CF1 CF2 –CF3 CF4 LOS: Calculate and interpret the net present value (NPV) and the internal rate of return (IRR) of an investment. Pages 40–41 The discount rate is most often going to be the firm’s weighted average cost of capital, but it doesn’t have to be. That will only be the case when the project has a level of risk similar to that of the existing company. The discount rate should be a rate that is commensurate to the level of risk the project creates for the firm. 2 Net present value (NPV) Focus On: Calculations Steps in calculating NPV Identify all the incremental cash flows associated with the project. Determine the appropriate discount rate. Using that discount rate, calculate the present value of all of the inflows (positive sign) and outflows (negative sign). Sum the present values together the result is the project’s NPV. Apply the NPV decision rule. If you have mutually exclusive projects accept the one with the highest NPV. 3 LOS: Calculate and interpret the net present value (NPV) and the internal rate of return (IRR) of an investment. Pages 40–41 The period of time associated with the discount rate and the frequency of cash flows must be the same. Normally, this will be annual rates and cash flows. The discount rate is most often going to be the firm’s weighted average cost of capital, but it doesn’t have to be. That will only be the case when the project has a level of risk similar to that of the existing company. .