assets , it is known as “Capital Investment” or “Capital
Expenditure”Spending may be for:
Maintenance
Profitability
Expansion
Indirect Purposes
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Chapter 7 Capital Budgeting and Basic Investment Appraisal Techniques
Содержание
- 1. Chapter 7 Capital Budgeting and Basic Investment Appraisal Techniques
- 2. Investment appraisalROCEPaybackNet present valueInternal rate of returnProbability Index
- 3. Capital InvestmentCapital Investment:When a business spends money
- 4. Compare:Revenue Expenditure: regular spending on the day-to-day
- 5. Capital Budgeting A capital budget:Is a programme
- 6. (1) ROCERules: If the expected ROCE >
- 7. A project involves the immediate purchase of
- 8. Average annual depreciation =($110,000-$10,000) ÷ 5
- 9. Other ROCEAverage carrying values of the assets
- 10. ROCE=(Average annual profit) ÷ (Average book value
- 11. ROCE : Pros & Cons
- 12. (2) Payback The payback period is the
- 13. Payback
- 14. Payback
- 15. The time value of moneyMoney received today
- 16. 1 The One-Period CaseIf you were to
- 17. Future ValueIn the one-period case, the formula
- 18. Present ValueIf you were to be promised
- 19. Present ValueIn the one-period case, the formula
- 20. 4.2 The Multiperiod CaseThe general formula for
- 21. Future ValueSuppose a stock currently pays a
- 22. Future Value and CompoundingNotice that the dividend
- 23. Future Value and Compounding
- 24. Present Value and DiscountingHow much would an
- 25. Multiple Cash Flows Consider an investment that pays
- 26. Multiple Cash FlowsPresent Value < Cost → Do Not Purchase
- 27. AnnuityA constant stream of cash flows with a fixed maturity
- 28. Annuity: ExampleIf you can afford a $400
- 29. What is the present
- 30. PerpetuityA constant stream of cash flows that lasts forever…
- 31. Perpetuity: ExampleWhat is the value of a
- 32. Relevant cash flowsOnly consider future, incremental cash flowsIgnore:‘sunk costs’Committed costsDepreciationInterest & dividend paymentsInclude opportunity costs
- 33. (3) Net Present Value (NPV) NPV is
- 34. NPV SolutionNPV = $10,000(PVIF13%,1) + $12,000(PVIF13%,2) +
- 35. Should this project be accepted?NPV Acceptance Criterion
- 36. Net present valueAll future cash flows are
- 37. (4) Internal Rate of Return (IRR)IRR is
- 38. $15,000 $10,000
- 39. IRR Solution (Try 10%)$40,000 = $10,000(PVIF10%,1) +
- 40. IRR Solution (Try 15%)$40,000 = $10,000(PVIF15%,1) +
- 41. .10 $41,444 .05 IRR $40,000 $4,603 .15 $36,841 IRR Solution (Interpolate)$1,444X=X.05$1,444 $4,603
- 42. .10 $41,444 .05 IRR $40,000 $4,603 .15 $36,841 IRR Solution
- 43. Should this project be accepted?IRR Acceptance Criterion
- 44. Internal rate of returnThe rate of interest (discount) at which the NPV = 0
- 45. IRR Decision RuleProjects should be accepted if
- 46. Internal rate of return
- 47. Internal Rate of ReturnExample You can purchase a
- 48. Internal Rate of ReturnExample You can purchase
- 49. Internal Rate of ReturnIRR=28%
- 50. Internal Rate of ReturnPitfall 1 - Lending
- 51. Internal Rate of ReturnPitfall 2 - Multiple
- 52. Internal Rate of ReturnPitfall 2 - Multiple
- 53. Internal Rate of ReturnPitfall 2 - Multiple
- 54. Internal Rate of ReturnPitfall 3 - Mutually
- 55. Internal Rate of ReturnPitfall 3 - Mutually Exclusive Projects
- 56. Internal Rate of ReturnPitfall 4 - Term
- 57. (5) Profitability IndexWhen resources are limited, the
- 58. The Profitability Index (PI)Minimum Acceptance Criteria: Accept
- 59. Profitability IndexThe aim when managing capital rationing
- 60. NPV with inflation
- 61. Lease versus buy decisionCompare the present value
- 62. Replacement decisionsUsed when the assets of a
- 63. Скачать презентанцию
Investment appraisalROCEPaybackNet present valueInternal rate of returnProbability Index
Слайды и текст этой презентации
Слайд 3Capital Investment
Capital Investment:
When a business spends money on new non-current
Spending may be for:
Maintenance
Profitability
Expansion
Indirect Purposes
Слайд 4Compare:
Revenue Expenditure: regular spending on the day-to-day running of the
business where the benefit is expected to last for only
one specific accounting periodWorking capital investment: investment in short-term net assets
Слайд 5Capital Budgeting
A capital budget:
Is a programme of capital expenditure
covering several years
Includes authorised future projects and projects currently under
considerationInvestment Appraisal : the process of appraising the potential projects
ROCE / AAR (Average Accounting Return)
Payback
NPV
IRR
Probability Index (PI Index)
Слайд 7A project involves the immediate purchase of an item of
plant costing $110,000. It would generate annual cash flows of
$24,400 for five years, starting in Year 1. The plant purchased would have a scrap value of $10,000 in five years, when the project terminates. Depreciation is on a straight-line basis.Calculate the ROCE.
Слайд 8Average annual depreciation
=($110,000-$10,000) ÷ 5 = $20,000
Average annual
profit= $24,400 - $20,000
=$4,400ROCE=(Average annual profit) ÷ (Initial capital cost) X 100%
= ($4,400 ÷ $110,000) X 100% = 4 %
Слайд 9Other ROCE
Average carrying values of the assets over their life
First
year’s profits
Total profits over the whole of the project’s life
Слайд 10ROCE=(Average annual profit) ÷ (Average book value of assets) X
100%
Average book value of assets
=(Initial capital cost + Final scrap value) ÷ 2=($110,000 + $10,000) ÷ 2
=$60,000
ROCE=$4,400 ÷ $60,000 X 100% = 7.33%
Слайд 12(2) Payback
The payback period is the time a project
will take to pay back the money spent on it.
It is based on expected cash flows and provides a measure of liquidity.Rules: only select projects which pay back within the specified time period
Payback Period < The specified time
Слайд 15The time value of money
Money received today is worth more
than the same sum received in the future because of:
The potential for earning interest
The impact of inflation
The effect of risk
Слайд 161 The One-Period Case
If you were to invest $10,000 at
5-percent interest for one year, your investment would grow to
$10,500.$500 would be interest ($10,000 × .05)
$10,000 is the principal repayment ($10,000 × 1)
$10,500 is the total due. It can be calculated as:
$10,500 = $10,000×(1.05)
The total amount due at the end of the investment is call the Future Value (FV).
Слайд 17Future Value
In the one-period case, the formula for FV can
be written as:
FV = C0×(1 + r)
Where C0 is cash
flow today (time zero), and r is the appropriate interest rate.
Слайд 18Present Value
If you were to be promised $10,000 due in
one year when interest rates are 5-percent, your investment would
be worth $9,523.81 in today’s dollars.The amount that a borrower would need to set aside today to be able to meet the promised payment of $10,000 in one year is called the Present Value (PV).
Note that $10,000 = $9,523.81×(1.05).
Слайд 19Present Value
In the one-period case, the formula for PV can
be written as:
Where C1 is cash flow at date 1,
and r is the appropriate interest rate.
Слайд 204.2 The Multiperiod Case
The general formula for the future value
of an investment over many periods can be written as:
FV
= C0×(1 + r)TWhere
C0 is cash flow at date 0,
r is the appropriate interest rate, and
T is the number of periods over which the cash is invested.
Слайд 21Future Value
Suppose a stock currently pays a dividend of $1.10,
which is expected to grow at 40% per year for
the next five years.What will the dividend be in five years?
FV = C0×(1 + r)T
$5.92 = $1.10×(1.40)5
Слайд 22Future Value and Compounding
Notice that the dividend in year five,
$5.92, is considerably higher than the sum of the original
dividend plus five increases of 40-percent on the original $1.10 dividend:$5.92 > $1.10 + 5×[$1.10×.40] = $3.30
This is due to compounding.
Слайд 24Present Value and Discounting
How much would an investor have to
set aside today in order to have $20,000 five years
from now if the current rate is 15%?$20,000
PV
Слайд 25Multiple Cash Flows
Consider an investment that pays $200 one year
from now, with cash flows increasing by $200 per year
through year 4. If the interest rate is 12%, what is the present value of this stream of cash flows?If the issuer offers this investment for $1,500, should you purchase it?
Слайд 28Annuity: Example
If you can afford a $400 monthly car payment,
how much car can you afford if interest rates are
7% on 36-month loans?
Слайд 29 What is the present value of a
four-year annuity of $100 per year that makes its first
payment two years from today if the discount rate is 9%?0 1 2 3 4 5
$100 $100 $100 $100
$323.97
$297.22
2-
Слайд 31Perpetuity: Example
What is the value of a British consol that
promises to pay £15 every year for ever?
The interest
rate is 10-percent.…
Слайд 32Relevant cash flows
Only consider future, incremental cash flows
Ignore:
‘sunk costs’
Committed costs
Depreciation
Interest
& dividend payments
Include opportunity costs
Слайд 33(3) Net Present Value (NPV)
NPV is the present value
of an investment project’s net cash flows minus the project’s
initial cash outflow.CF1 CF2 CFn
(1+k)1 (1+k)2 (1+k)n
+ . . . +
+
- ICO
NPV =
Слайд 34NPV Solution
NPV = $10,000(PVIF13%,1) + $12,000(PVIF13%,2) + $15,000(PVIF13%,3) + $10,000(PVIF13%,4)
+
$ 7,000(PVIF13%,5) - $40,000NPV = $10,000(.885) + $12,000(.783) + $15,000(.693) +
$10,000(.613) + $ 7,000(.543) - $40,000
NPV = $8,850 + $9,396 + $10,395 + $6,130 + $3,801 - $40,000
= - $1,428
Слайд 35Should this project be accepted?
NPV Acceptance Criterion
No! The
NPV is negative.
This means that the project is reducing
shareholder wealth. [Reject as NPV < 0 ]The management of Basket Wonders has determined that the required rate is 13% for projects of this type.
Слайд 36Net present value
All future cash flows are discounted to their
present value and then added
A positive result indicates the project
should be acceptedA negative result and the project should be rejected
Слайд 37(4) Internal Rate of Return (IRR)
IRR is the discount rate
that equates the present value of the future net cash
flows from an investment project with the project’s initial cash outflow.The IRR represents the discount rate at which the NPV of an investment is zero.
CF1 CF2 CFn
(1+IRR)1 (1+IRR)2 (1+IRR)n
+ . . . +
+
ICO =
Слайд 38$15,000 $10,000 $7,000
IRR
Solution
$10,000 $12,000
(1+IRR)1 (1+IRR)2
Find the interest
rate (IRR) that causes the discounted cash flows to equal $40,000.+
+
+
+
$40,000 =
(1+IRR)3 (1+IRR)4 (1+IRR)5
Слайд 39IRR Solution (Try 10%)
$40,000 = $10,000(PVIF10%,1) + $12,000(PVIF10%,2) +
$15,000(PVIF10%,3) + $10,000(PVIF10%,4) +
$
7,000(PVIF10%,5) $40,000 = $10,000(.909) + $12,000(.826) +
$15,000(.751) + $10,000(.683) +
$ 7,000(.621)
$40,000 = $9,090 + $9,912 + $11,265 +
$6,830 + $4,347
= $41,444 [Rate is too low!!]
Слайд 40IRR Solution (Try 15%)
$40,000 = $10,000(PVIF15%,1) + $12,000(PVIF15%,2) +
$15,000(PVIF15%,3) + $10,000(PVIF15%,4) +
$ 7,000(PVIF15%,5) $40,000 = $10,000(.870) + $12,000(.756) +
$15,000(.658) + $10,000(.572) +
$ 7,000(.497)
$40,000 = $8,700 + $9,072 + $9,870 +
$5,720 + $3,479 = $36,841 [Rate is too high!!]
Слайд 41 .10 $41,444
.05 IRR $40,000 $4,603
.15 $36,841
IRR Solution (Interpolate)
$1,444
X
=
X
.05
$1,444
$4,603
Слайд 42 .10 $41,444
.05 IRR $40,000 $4,603
.15 $36,841
IRR Solution (Interpolate)
$1,444
X
X =
X =
.0157
IRR = .10 + .0157 = .1157 or 11.57%
($1,444)(0.05)
$4,603
Слайд 43Should this project be accepted?
IRR Acceptance Criterion
No! The
firm will receive 11.57% for each dollar invested in this
project at a cost of 13%. [ IRR < Hurdle Rate ] The management of Basket Wonders has determined that the hurdle rate is 13% for projects of this type.
Слайд 45IRR Decision Rule
Projects should be accepted if their IRR is
greater than the cost of capital
Слайд 47Internal Rate of Return
Example
You can purchase a turbo powered machine
tool gadget for $4,000. The investment will generate $2,000 and
$4,000 in cash flows for two years, respectively. What is the IRR on this investment?
Слайд 48Internal Rate of Return
Example
You can purchase a turbo powered
machine tool gadget for $4,000. The investment will generate $2,000
and $4,000 in cash flows for two years, respectively. What is the IRR on this investment?
Слайд 50Internal Rate of Return
Pitfall 1 - Lending or Borrowing?
With some
cash flows (as noted below) the NPV of the project
increases, the discount rate increases.This is contrary to the normal relationship between NPV and discount rates.
Слайд 51Internal Rate of Return
Pitfall 2 - Multiple Rates of Return
Certain
cash flows can generate NPV=0 at two different discount rates.
The
following cash flow generates NPV=$A 3.3 million at both IRR% of (-44%) and +11.6%. Cash Flows (millions of Australian dollars)
Слайд 52Internal Rate of Return
Pitfall 2 - Multiple Rates of Return
Certain
cash flows can generate NPV=0 at two different discount rates.
The
following cash flow generates NPV=$A 3.3 million at both IRR% of (-44%) and +11.6%. 600
NPV
300
0
-30
-600
Discount Rate
IRR=11.6%
IRR=-44%
Слайд 53Internal Rate of Return
Pitfall 2 - Multiple Rates of Return
It
is possible to have a zero IRR and a positive
NPV
Слайд 54Internal Rate of Return
Pitfall 3 - Mutually Exclusive Projects
IRR sometimes
ignores the magnitude of the project.
The following two projects illustrate
that problem.
Слайд 56Internal Rate of Return
Pitfall 4 - Term Structure Assumption
We assume
that discount rates are stable during the term of the
project.This assumption implies that all funds are reinvested at the IRR.
This is a false assumption.
Слайд 57(5) Profitability Index
When resources are limited, the profitability index (PI)
provides a tool for selecting among various project combinations and
alternativesA set of limited resources and projects can yield various combinations.
Слайд 58The Profitability Index (PI)
Minimum Acceptance Criteria:
Accept if PI >
1
Ranking Criteria:
Select alternative with highest PI
Слайд 59Profitability Index
The aim when managing capital rationing is to maximize
the PV earned per $1 invested in projects.
Rules : The
highest weighted average PI can indicate which projects to select.
Слайд 61Lease versus buy decision
Compare the present value cost of leasing
with the present value cost of borrowing to buy
Leasing cash
flows:Rental payments
Tax relief on the rental payments
Buying cash flows:
Asset purchase
Writing down allowances
Слайд 62Replacement decisions
Used when the assets of a project need replacing
periodically
Choose the option with the lowest equivalent annual cost
The optimum
replacement cycle is that period which has the lowest EAC
