Presentation on theme: "Capital Budgeting Techniques"— Presentation transcript:
1 Capital Budgeting Techniques Chapter IX TutorialCapital Budgeting Techniques
2 Capital Budgeting Techniques Calculate, interpret, and evaluate the payback period.Calculate, interpret, and evaluate the present value (NPV).Calculate, interpret, and evaluate the internal rate of return (IRR).
3 Exercise 9 - 3Project Kelvin will cost $45,000 and generate cash inflows of $20,000 per year for the next 3 yearsProject Thompson will cost $275,000 and generate cash inflows of $60,000 per year for 6 years.Using an 8% cost of capital, calculate each project’s NPV and make a recommendation based on your findings
5 Exercise 9 - 4Calculate the IRR for each of the following projects and recommend best project.Project T-shirt requires initial investment of $15,000 and generates cash inflows of $8,000 per year for 4 years.Project Board Shorts requires an initial investment of $25,000 and produces cash inflows of $12,000 per year for 5 years.
6 Exercise 9 - 4 Solution Project T-Shirt PV = -15,000 N = 4 PMT = 8,000 Solve for I IRR = 39.08%
7 Problem 9 - 1 Payback period Jordan Enterprises is considering a capital expenditure that requires an initial investment of $42,000 and returns after-tax inflows of $7,000 per year for 10 years. The firm has maximum acceptable payback period of 8 years.Determine the payback period for this project.Should the company accept the project? Why?
8 Problem Solution(a) $42,000 / $7,000 = 6 years (b) The company should accept the project, since 6 < 8.
9 Problem 9 - 3Choosing between 2 projects with acceptable payback periodsEach project requires $100,000 investmentMaximum payback period 4 yearsDetermine payback period of each project.Which one should they choose?Explain why is one of the projects a better choice.YearProject AProject B1$10,000$40,0002$20,000$30,000345
13 Problem 9 - 7NPVCar inventor has offered Simes choice of either one time payment $1,500,000 today or a series of 5 year-end payments of $385,000If Simes has cost of capital 9%, which form of payment would they choose?What yearly payment would make the two offers identical in value at a cost of capital of 9%Would your answer be different if the yearly payments were made at the beginning of each year? Show the difference.The after-tax cash inflows are projected to $250,000 per year for 15 years. Will this factor change the decision?
15 Problem 9 - 9 NPV- exclusive projects Hook industries is considering the replacement of a drill pressCost of capital is 15%Calculate NPV of each press.Evaluate acceptability.Rank the presses best to worstABCInit. Inv.$85,000$60,000130,000YearCash Inflows (CFt)1$18,000$12,000$50,0002$14,000$30,0003$16,000$20,000456$25,0007$40,0008
18 Problem 9 - 13 IRR, investment life and cash inflows Oak enterprises accepts projects earning more than 15%. Oak is considering a 10 year project that provides $10,000 annual cash inflows and requires $61,450 initial investment.Determine IRR. Is it acceptable?Assuming cash inflows stay same how many additional years would the flows have to continue to make IRR 15%?With given life, initial investment, and cost of capital what is the minimum annual cash inflow the firm should accept?
20 Problem 9 - 21 Integrative - Complete investment decision Existing New MACRSYearPercentage120%232%319%412%565%Integrative - Complete investment decisionExisting10yrs ago at $1,000,000Sells $1,200,000NewCost $2,200,0005yrs, MACRSSales $1,600,000 increase per yearCosts 50% of SalesCost of Capital 11%Tax 40%Calculate initial investment.Determine incremental operating cash flows.Determine the terminal cash flow.Depict on a time line the relevant cash flows.