Corporate Finance - Formative Assessment

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CORPORATE FINANCE - FORMATIVE ASSESSMENT Generally, there are many methods to evaluate an investment, in order to undertaking or avoiding it, and of course to choose an investment over another. The main and most used methods are the NPV rule, the IRR rule (the two fundamental discounted cash flow methods) and the Payback rule; however there are many others more, less used but still important to be cited as adjusted present value, discounted payback period, profitability index, and accounting rate of return. Managers and whom it may concern ordinarily use more than one solely investment appraisal method, though sometimes these methods may suggest discording answers. The NPV rule, however, is the most reliable and this means that every time the methods used disagree with the NPV one, they will lead us to a worse decision that could decrease our wealth. Let’s distinguish and outline in a more specific way method by method and see how and why NPV should be the most reliable. The NPV consists of the sum of all the present values of the cash flows of an investment, both incoming and outgoing, with a given “r” as the opportunity cost (discount rate). Once we have obtained the result: - if we are dealing with a stand-alone project we undertake it only if the result is positive, while on the other hand - if we are dealing with many investments, we accept the one with the highest NPV. A positive NPV means that the investment is expected to add value to the firm, and consequently

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