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1、M.Sc.FinanceM.Sc.Investment&FinanceM.Sc.InternationalBanking&FinanceandM.Sc.InternationalAccounting&Finance2011/201240901–FinanceIINVESTMENTCRITERIAJRDavies120Inthischapterwewillevaluatethecriteriathataremostfrequentlyrecommendedinthefinancialliteraturefo
2、rtheevaluationofinvestments,thenetpresentvalue(NPV)andtheinternalrateofreturn(IRR)rules.Wewillexaminetheconsistencyoftheseinvestmentcriteriawiththeobjectiveofservingtheinterestsoftheshareholders.Wewillconsidersomeoftheproblemsposedbytheuseoftheinternalrat
3、eofreturnasaninvestmentcriterionanddiscusssomeofthewaysinwhichtherateofreturncanbemodifiedtoovercometheseproblems.Wewillalsoconsidertwocriteriathatarewidelyusedinpracticedespitesomeobvioustheoreticalshortcomings,thepaybackperiodandtheaccountingrateofretur
4、n.Inaddition,wewilldiscusstheproblemsofcapitalrationing–determiningtheoptimalchoiceofinvestmentswhenthereareinsufficientfundsavailabletofundallprofitableprojects.ObjectivesBytheendofthechapteryoushouldbeableto:°appreciatetheadvantagesofusingthenetpresentv
5、aluetoevaluateinvestmentproposals°identifythestrengthsandweaknessesoftheinternalrateofreturnasaninvestmentcriteria°recognisetheproblemsposedfortheinternalrateofreturnbymutuallyexclusiveinvestmentsandinvestmentscharacterisedbymorethanonebreakevenrateofretu
6、rn°usethepaybackperiodtoassessinvestmentswhilstappreciatingitslimitationsasaninvestmentcriterion°usetheaccountingrateofreturntoevaluateinvestmentsandidentifyitsshortcomings°appreciatethenatureofthecapitalrationingproblemandsomeofthetechniquesemployedtodea
7、lwiththeproblem.1Investmentcriteria:discountedcash?owrulesNetpresentvalueruleAswehaveseen,thenetpresentvalueapproachtotheappraisalofaninvestmentrequirestheconversionofallfutureexpectedcashflowsintotheirequivalentvaluestodaysoastoallowforthetimecostofmoney
8、.Thediscountedcashflowsarethensummedtoseewhetherornottheinvestmentcanbeexpectedtoproduceanetbenefitorloss,referredtoasthenetpresentvalue.Apositivenetpresentvalueindicatesthatthecapitalcommittedtoaninvestmentcanberec
