Investment decision rules, these are rules or techniques that organizations use, can use. To determine whether or not they should invest in a particular asset, whether they should merge or acquire a different company. Whether they should engage in capital expenditures. Your organization probably uses one or more of these rules when determining whether or not they should engaged in CapX. And we're going to talk through briefly what the different rules are right now. And then we're going to talk more in depth about the calculations of each one of these different techniques. Net present value, we've talked about net present value. This is the present value, the discounted value of your future streams of income, net of your initial cost. As in terms of an investment technique, you would then look at one or more investment opportunities and identify the opportunity that has the highest NPV. The greatest net present value. You could look at an individual investment and identify whether its NPV is positive or negative. You'd want to take an investment on if NPV is positive and probably not if it's negative. Or if looking at more than one ,choose the investment that has the highest net present value. The payback period, both discounted and undiscounted. There's a way to capture and measure the number of years or the number of periods that it's going to take for the investment to recoup the initial cost. So let's suppose that I have a capital expenditure that's going to cost me a million dollars. I might use the payback period to identify whether I'm going to get my million dollars back in 12 months, or 16 months, or 18 months, 24 months, 2 years, 3 years. And I may set up a decision technique tree that says I will or won't engage in a particular investment unless I can get my money back in two years. In this scenario, I would probably choose the investment that I get my money back sooner. So I would choose a capital expenditure project where the payback period is two years relative to two and a half years, or three years relative to five years. The average accounting rate of return is a technique where we use not only the discounted or we can use the discounted stream. But we also account for the fact that we've got taxes and that we haveaA depreciation schedule in place for our capital. And so what we want to do is we want to account for depreciation, account for our taxes. And identify the rate of return once we have engaged in the accounting practices involved in that particular investment. The internal rate of return is a technique where we have to capture and calculate the rate of return, the discount rate such that the NPV and our future cash flows are even. So we ask the question what is the discount rate such that our NPV is zero. Or that our costs are exactly equal to our discounted stream of future cash flows. Then we can choose the investment with the highest internal rate of return. We also have this thing called profitability index. The profitability index Is where we're taking our present value, our discounted stream as a ratio of our initial cost. Each one of these techniques has its pluses and its minuses, our pros and our cons. But we can use them in concert or individually to make good decisions. Good finance leads to good decisions.
