Download presentation

Presentation is loading. Please wait.

Published byReed Tag Modified over 2 years ago

2
Chapter 20 Capital budgeting Decisions

3
What is a Capital Expenditure? n A long-term decision of whether or not to make an investment today which will bring future returns. n Those “future returns” must be greater than the initial cost of the investment. n This creates a complication - the time value of money!

4
Cash Flows n The initial cash outlay is compared to the future cash “inflows” n These future inflows can include n cash receipts n cash receipts less cash payments n savings of cash payments

5
Cost of Capital n In order to make a capital expenditure, a Co. must have cash. n Obtaining financing from creditors and investors costs $. n This is called the cost of capital. n An investment S/B made as long as the C of C is < or = the return on investment.

6
The Cost of Capital represents the minimum required rate of return needed before a capital expenditure should be made. n In other words, it is the cuttoff rate.

7
Time Value of Money n “A dollar today is worth more than a dollar tomorrow.” Why?

8
Since the initial capital expenditure is made in “todays dollars”, we must convert future cash flows to todays dollars in order to determine whether to make the investment.

9
Present Value (pages 711- 716) n Assume the following: You made a $100 investment in a savings account which earns 6% interest compounded annually. After three years you have the following: n Yr1: (100 x.06) + 100 = 106 n Yr2: (106 x.06) + 106 = 112.36 n yr3: (112.36 x.06) + 112.36 = 119.10 n $119.10 is the future value & $100 is the present value.

10
Think of the present value as the amount of the future value with the interest taken out! n What if we know the future value is $119.10 and want to “convert” it to present value? n Use the table on page 732: 6% for 3 periods = factor of.8396 n.8396 x $119.10 = $99.996 (or $100 rounded)

11
Above Example - single amount was used. A series of equal payments is an annuity. n Use table on page 733!

12
Firms use a variety of “Tools” to make capital budgeting decisions: n NPV n Payback n Aver. Rate of Return

13
NPV - steps: n 1. Calculate, using PV tables, the PV of future cash flows n Use the cost of capital (ie, the required rate of return) n 2. Calculate the amount of the initial cash outlay for the investment n This is already the PV! n 3. #1-#2 = the NPV

14
How to evaluate the NPV: n if zero or positive, accept investment because the return if > or = the cost of capital. n If negative - don’t accept the project because the return is < required rate.

15
Payback n evaluates how long it will take to “recap” your initial investment. n Ignores the time value of money & the return on investment. n Only takes return of investment into consideration.

16
Average rate of return n Usually expressed as a % ARR = Total Cash Receipts-Total cash payment Years X Investment If ARR < C of C, don’t invest. n Also ignores the time value of $

17
Be sure to read through the examples in the text!

18
The End

Similar presentations

OK

TIME VALUE OF MONEY A dollar on hand today is worth more than a dollar to be received in the future because the dollar on hand today can be invested to.

TIME VALUE OF MONEY A dollar on hand today is worth more than a dollar to be received in the future because the dollar on hand today can be invested to.

© 2017 SlidePlayer.com Inc.

All rights reserved.

Ads by Google

Ppt on library management system project Ppt on indian road signs Ppt on direct taxation in india Ppt on waxes are lipids Ppt on search and rescue Ppt on world sports day Ppt on structure of chromosomes in prokaryotes Ppt on p&g products online Ppt on ip address classes subnet Ppt on successes and failures quotes