# Capital budgeting tools-MODEL - 1 2 3 4 5 6 7 8 9 10 11 12...

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10model 3/23/2017 13:40 Chapter 10. Model for Capital Budgeting Tools In this file we use Excel to do most of the calculations explained in Chapter 10. First, we analyze Pro whose cash flows are shown immediately below in both tabular and time line formats. Spreadsheet an set up vertically, in a table with columns, or horizontally, using time lines. For short problems, with j we generally use the time line format because rows can be added and we can set the problem up as a statements. For long problems, it is often more convenient to use a tabular layout. Expected after-tax Project S Year (t) Project S Project L 0 1 2 0 (\$1,000) (\$1,000) (1,000) 500 400 1 500 100 2 400 300 Project L 3 300 400 4 100 600 0 1 2 (1,000) 100 300 Capital Budgeting Decision Criteria Here are the five key methods used to evaluate projects: (1) payback period, (2) discounted payback present value, (4) internal rate of return, and (5) modified internal rate of return. Using these criteri analysts seek to identify those projects that will lead to the maximization of the firm's stock price. PAYBACK PERIOD The payback period is defined as the expected number of years required to recover the investment, a first formal method used to evaluate capital budgeting projects. First, we identify the year in which cash inflows exceed the initial cash outflows. That is the payback year. Then we take the previous ye the unrecovered balance at the end of that year divided by the following year's cash flow. Generally shorter the payback period, the better the investment. Project S Time period: 0 1 2 3 4 Cash flow: (1,000) 500 400 300 100 Cumulative cash flow: (1,000) (500) (100) 200 300 0.00 0.00 0.00 1.00 0.00 Use Logical " 0.00 0.00 0.00 2.33 0.00 the first po Payback: 2.33 Use Logical I Use Statistica Alternative calculation: 2.33 Alternative: Use nested IF statements to display payb find payback. Fx > Logical > IF > OK, statements. Project L Time period: 0 1 2 3 4 Cash flow: (1,000) 100 300 400 600 Cumulative cash flow: (1,000) (900) (600) (200) 400 net cash flows (CF t ) A B C D E F G H 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 29 30 31 32 33 34 35 36 37 38 39 40 41 42 43 44 45 46 47 48
Payback: 3.33 Uses IF statement. DISCOUNTED PAYBACK PERIOD Discounted payback period uses the project's cost of capital to discount the expected cash flows. The discounted payback period is identical to the calculation of the regular payback period, except you m calculation on a new row of discounted cash flows. Note that both projects have a cost of capital of 1 WACC = 10% Project S Time period: 0 1 2 3 4 Cash flow: (1,000) 500 400 300 100 Disc. cash flow: (1,000) 455 331 225 68 Disc. cum. cash flow: (1,000) (545) (215) 11 79 Discounted Payback: 2.95 Uses IF statement. A B C D E F G H 49 50 51 52 53 54 55 56 57 58 59 60 61 62 63 64 65 66
Project L Time period: 0 1 2 3 4 Cash flow: (1,000) 100 300 400 600 Disc. cash flow: (1,000) 91 248 301 410 Disc. cum. cash flow: (1,000) (909) (661) (361) 49 Discounted Payback: 3.88 Uses IF statement. The inherent problem with both paybacks is that they ignore cash flows that occur after the payback While the discounted method accounts for timing issues (to some extent), it still falls short of fully an projects. However, all else equal, these two methods do provide some information about projects' liq NET PRESENT VALUE (NPV)