Download presentation

Presentation is loading. Please wait.

Published byJoey Osmer Modified over 2 years ago

1
1 FINANCE 7311 CAPITAL BUDETING

2
2 Outline 4 Projects 4 Investment Criteria 4 NPV v. IRR 4 Sources of NPV 4 Project Cash Flow Checklist

3
3 Projects A project is any potential real investment opportunity Distinguish real from financial Mutually Exclusive - can do only one Independent - decision about one does not affect decision w/r/t the others Replacement - special case

4
4 Investment Criteria Investment criteria are the rules by which we decide whether or not to accept a particular project; consider the following :

5
5 Accounting Rate of Return ARR = Avg. Income / Avg. Investment Uses Income rather than Cash Flow Ignores Time Value of Money

6
6 Payback Years needed to recover initial investment To Find: Calculate where cumulative cash flows become positive Project A:2 1/6 years Project B:2 6/7 years

7
7 Problems with Payback Ignores Time Value of Money Can use Discounted Payback; Why? Ignores CF’s after payback To see: Assume Project B’s cash flow in year 4 is 1,000,000; how does this affect payback

8
8 Net Present Value This rule is always consistent with maximizing the value of the firm Economically, take all projects for which benefits > costs (in PV dollars) Mathematically, sum the present values of all the cash flows

9
9 Net Present Value

10
10 NPV example

11
11 Internal Rate of Return (IRR) IRR - That rate which causes NPV to = 0.

12
12 IRR Independent Projects - select all projects for which IRR > Cost of Capital Mutually Exclusive - select project with highest IRR Use ‘well-designed’ spreadsheet

13
13 Comparison of NPV & IRR Business people are accustomed to thinking in rates of return, so does it matter which of NPV or IRR we use? Independent - the two rules are equivalent NPV > 0 IRR > Cost of Capital

14
14 Comparison of NPV & IRR Mutually Exclusive Projects - can get different answers NPV Profile for Example Reinvestment Assumption

15
15 NPV v. IRR Example Project 1:(100,000)125,000 Project 2: 1,000 2,000 NPV IRR Project 113,636 25% Project 2 818100%

16
16 NPV v. IRR, cont. IRR ==> Do Project 2 NPV ==> Do Project 1 Problem: Reinvestment Assumption What are you going to do with the other $99,000?

17
17 Profitability Index PV Cash Inflows / PV Cash Outflows Independent: Choose all with PI > 1 Mutually Exclusive: Choose highest PI Project 1:1.136 Project 2:1.818 May be useful for capital rationing

18
18 Other Real Options Option to Expand Option to Abandon Strategic Options Excluding biases NPV down Decision Tree: Capital Budgeting should be dynamic, not static

19
19 Source of NPV Market Opportunities - ‘deviations from equilibrium’ 4 Economies of Scale 4 Cost Advantages 4 Product differentiation 4 Distribution Advantage 4 Regulatory Protection

20
20 Relevant Cash Flows We can always write: EBIT + Depreciation - Taxes (t x EBIT) = Operating Cash Flow - ∆ NWC - Capital Spending = FCF

21
21 Cash Flows 1. Focus on Cash Flows; not accounting #’s Depreciation Not a cash flow Affects Cash Flow through depreciation Capital spending Capitalized for accounting purposes Cash outflow for finance purposes

22
22 Project Cash Flows 2 Focus on Incremental Cash Flows “What is different if project is accepted?” Ý Sunk Costs - those costs which have been incurred and are not affected by project decision Ý Opportunity Cost - highest value use of an asset if not used in project

23
23 Project CF’s, cont. 3 Externalities - less obvious costs/benefits which should be included in analysis 4 Change in NWC - often a cash outflow initially and cash inflow at end 5 Cash flows should be after tax ∆Rev/Exp x (1-t) Depreciation x t 6 Do not include interest as a cash flow

24
24 Project CF’s, cont. l Replacement problem - should you keep an existing asset, or replace it with a new one 4 ∆ in Cash Flows 4 Net of tax proceeds from disposal of existing asset

Similar presentations

OK

© 2009 Cengage Learning/South-Western Capital Budgeting Chapter 8.

© 2009 Cengage Learning/South-Western Capital Budgeting Chapter 8.

© 2017 SlidePlayer.com Inc.

All rights reserved.

Ads by Google

Ppt on solid dielectrics in series Ppt on endotracheal tubes Ppt on bloodstain pattern analysis Ppt on crime file system Ppt on conservation of momentum equations Ppt on history of national flag of india Ppt on obesity and nutrition Ppt on network switching modes Ppt on obesity management matrix Ppt on viruses and anti viruses history