IFM9 Ch 12 Show

IFM9 Ch 12 Show - Chapter 12 Capital Budgeting Decision...

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1 Chapter 12 Capital Budgeting: Decision Criteria
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2 Topics Overview and “vocabulary” Methods Payback, discounted payback NPV IRR, MIRR Profitability Index Unequal lives Economic life
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3 What is capital budgeting? Analysis of potential projects. Long-term decisions; involve large expenditures. Very important to firm’s future.
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4 Steps in Capital Budgeting Estimate cash flows (inflows & outflows). Assess risk of cash flows. Determine r = WACC for project. Evaluate cash flows.
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5 Independent versus Mutually Exclusive Projects Projects are: independent, if the cash flows of one are unaffected by the acceptance of the other. mutually exclusive, if the cash flows of one can be adversely impacted by the acceptance of the other.
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6 What is the payback period? The number of years required to recover a project’s cost, or how long does it take to get the business’s money back?
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7 Payback for Franchise L (Long: Most CFs in out years) 10 80 60 0 1 2 3 -100 = CF t Cumulative -100 -90 -30 50 Payback L 2 + 30/80 = 2.375 years 0 100 2.4
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8 Franchise S (Short: CFs come quickly) 70 20 50 0 1 2 3 -100 CF t Cumulative -100 -30 20 40 Payback S 1 + 30/50 = 1.6 years 100 0 1.6 =
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9 Strengths and Weaknesses of Payback Strengths: Provides an indication of a project’s risk and liquidity. Easy to calculate and understand. Weaknesses: Ignores the TVM. Ignores CFs occurring after the payback period.
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10 10 80 60 0 1 2 3 CF t Cumulative -100 -90.91 -41.32 18.79 Discounted payback 2 + 41.32/60.11 = 2.7 yrs PVCF t -100 -100 10% 9.09 49.59 60.11 = Recover invest. + cap. costs in 2.7 yrs. Discounted Payback: Uses discounted rather than raw CFs.
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11 NPV: Sum of the PVs of all cash flows. Cost often is CF 0 and is negative. NPV = n t = 0 CF t (1 + r) t . NPV = n t = 1 CF t (1 + r) t . - CF 0 .
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12 What’s Franchise L’s NPV? 10 80 60 0 1 2 3 10% L’s CFs: -100.00 9.09 49.59 60.11 18.79 = NPV L NPV S = $19.98.
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13 Calculator Solution: Enter values in CFLO register for L. -100 10 60 80 10 CF 0 CF 1 NPV CF 2 CF 3 I = 18.78 = NPV L
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14 Rationale for the NPV Method NPV = PV inflows – Cost This is net gain in wealth, so accept project if NPV > 0. Choose between mutually exclusive projects on basis of higher NPV. Adds most value.
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15 Using NPV method, which franchise(s) should be accepted? If Franchise S and L are mutually exclusive, accept S because NPV s > NPV L . If S & L are independent, accept both; NPV > 0.
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16 Internal Rate of Return: IRR 0 1 2 3 CF 0 CF 1 CF 2 CF 3 Cost Inflows IRR is the discount rate that forces PV inflows = cost. This is the same as forcing NPV = 0.
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NPV: Enter r, solve for NPV. IRR:
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This note was uploaded on 04/12/2008 for the course BUS 420 taught by Professor Poindexter during the Spring '08 term at N.C. State.

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IFM9 Ch 12 Show - Chapter 12 Capital Budgeting Decision...

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