Evaluating Multiperiod Performance

17 Pages Posted: 23 Jun 2009

See all articles by Sherwood C. Frey

Sherwood C. Frey

University of Virginia - Darden School of Business

Abstract

This technical note begins with the estimation of cash flows and then introduces the technique of discounted cash flows by first addressing accumulated value and then computing present values. The note also discusses net present value, internal rate of return, hurdle rate, and effective versus nominal rates of return. In addition, the note explores streams in perpetuity and the conditions when pretax analyses are appropriate.

Excerpt

UVA-QA-0518

EVALUATING MULTIPERIOD PERFORMANCE

A tract of land is developed for the resale value of the lots into which it will be subdivided. A promising new product is nationally introduced on the basis of its future sales and subsequent profits. A piece of equipment is ordered for the improved operating efficiency and increased capacity that it will provide relative to the piece it replaces. A corporate bond is purchased for its coupons and the ultimate repayment of its par value.

These decisions are similar in that each requires the investment of money in anticipation of benefits whose realization will be spread over time. The value of such an investment depends on many factors including: the magnitude of the benefits, the timing of those benefits, and the degree of uncertainty in actually receiving the anticipated benefits. Although the prediction of future benefits is perhaps the most significant challenge in appraising investments, the careful and consistent consideration of the effects of time is necessary, even when those benefits are known. Suppose the monetary return of an investment far exceeds the initial investment, but the return is delayed into the distant future. Does the magnitude of the return justify the wait? Suppose one investment yields greater monetary returns than another does, but the returns of the first extend over a longer period than the second. Which is better or is either desirable?

This note offers a systematic approach to answering these questions. The focus will be on the measurement of the monetary returns of an investment (cash flow) and on the evaluation of the effects of timing on the value of those returns (discounted cash flows). The discussion assumes that the returns are known with certainty. The concepts and techniques for explicitly addressing uncertainty are discussed in other notes.

Cash Flow

. . .

Keywords: discounted cash flow, cash flow, internal rate of return, net present value, time value of money

Suggested Citation

Frey, Sherwood C., Evaluating Multiperiod Performance. Darden Case No. UVA-QA-0518. Available at SSRN: https://ssrn.com/abstract=1422950

Sherwood C. Frey (Contact Author)

University of Virginia - Darden School of Business ( email )

P.O. Box 6550
Charlottesville, VA 22906-6550
United States

HOME PAGE: http://www.darden.virginia.edu/faculty/frey.htm

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