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Graphs the relationship between net present value and discount rates.

A graph with the discount rate on the x- axis and the NPV of the investment on the y-axis.

Higher discount rate means cash flows that occur sooner are more influential to NPV. Since the earlier payments tend to be the outflows, the NPV profile generally shows an inverse relationship between the discount rate and NPV

Discount rate at which the NPV equals 0 is called the internal rate of return (IRR)

A Company is considering two projects with the following cash flows. The Company's cost of capital is 10 percent.

Expected Net Cash Flows (in millions)

Year Project L Project S

0 -$100 -$100 1 10 70

2 60 503 80 20

EXAMPLE:

1) Compute for the NPVs of the project.

2) Graph the points.

Using the formula:

Payback Period

The length of time required for an investment’s cash flows to cover its cost.

Discounted Payback

The length of time required for an investment’s cash flows, discounted at the investment’s cost of capital, to cover its cost.

𝑃𝑎𝑦𝑏𝑎𝑐𝑘=𝑁𝑢𝑚𝑏𝑒𝑟 𝑜𝑓 𝑦𝑒𝑎𝑟𝑠𝑝𝑟𝑖𝑜𝑟 𝑡𝑜 𝑓𝑢𝑙𝑙𝑟𝑒𝑐𝑜𝑣𝑒𝑟𝑦+𝑈𝑛𝑟𝑒𝑐𝑜𝑣𝑒𝑟𝑒𝑑𝑐𝑜𝑠𝑡 𝑎𝑡 𝑠𝑡𝑎𝑟𝑡 𝑜𝑓 𝑦𝑒𝑎𝑟h𝐶𝑎𝑠 𝑓𝑙𝑜𝑤𝑑𝑢𝑟𝑖𝑛𝑔 𝑓𝑢𝑙𝑙𝑟𝑒𝑐𝑜𝑣𝑒𝑟𝑦 𝑦𝑒𝑎𝑟

= 2.33

𝑑𝑖𝑠𝑐𝑜𝑢𝑛𝑡𝑒𝑑𝐶𝐹=500

(1+.10)1

Assume 10% cost of capital

= 2.95