FINA2010 Lecture 5.pptx - FINA2010 Financial Management Lecture 5 Capital Budgeting II Instructor Prof Si Cheng 1 Last Lecture \u2022 \u2022 Net Present

FINA2010 Lecture 5.pptx - FINA2010 Financial Management...

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FINA2010FinancialManagementLecture5:CapitalBudgetingIIInstructor:Prof.SiCheng1
LastLectureNetPresentValue(NPV)PaybackandDiscountedPaybackPeriodAverageAccountingReturn(AAR)InternalRateofReturn(IRR)ProfitabilityIndex(PI)2
LectureOutlineIncrementalCashFlowsProFormaFinancialStatementsandProjectCashFlowsDepreciationandSalvageValueAlternativeDefinitionsofOperatingCashFlowSomeSpecialCasesofDiscountedCashFlowAnalysis3
LearningObjectivesBeabletodeterminetherelevantcashflowsforvarioustypesofproposedinvestments.Understandthevariousmethodsforcomputingoperatingcashflow.Beabletoassessacost-cuttingproject.Beabletosetabidpriceforaproject.Beabletoevaluatetheequivalentannualcostofaproject.Beabletoassessareplacementproject.4
NPVAnalysis:BestDecisionMethodNPVisthebestcapitalbudgetingdecisionmethodtoapply.ExaminethecashinflowsandoutflowsEstimatetherequiredrateofreturnandusethattofindthePVofthecashinflowsandoutflows.Evaluatingtheprojectedcashflowsgivesmanagementavalidcriterionforchoosingthoseprojectsthatpromisethemostvalueaccretiontotheorganization.5
CashFlowsinaTypicalProject6
IdentifyRelevantCashFlowsRule#1:capitalbudgetingdecisionsmustbebasedoncashflowsratherthanaccountingearnings.AccountingtreatmentofcapitalexpendituresCashoutlayappearsasadepreciationexpenseoveritsusefullifeDepreciationexpensesactualcashoutflows7
IdentifyRelevantCashFlowsRule#2:onlyincrementalcashflowsarerelevant.Firm’scashflowswiththeprojectminusthefirm’scashflowswithouttheproject.Thecashflowsthatshouldbeincludedinacapitalbudgetinganalysisareonlythosethatwilloccuriftheprojectisaccepted.WillthiscashflowoccurONLYifweaccepttheproject?Iftheansweris‘partofit’,thenweshouldincludethepartthatoccursbecauseoftheproject.8
TypesofCashFlowEffectsSunkcosts:coststhathavealreadybeenincurredandcannotberemovednotrelevantOpportunitycosts:costsofoptionswhichmustbeforgonebytakingtheprojectrelevantE.g.,theuseoflandorplantthatisalreadyowned9
TypesofCashFlowEffectsSideeffects(orExternalities)relevantPositivesideeffects:benefitstootherprojects,e.g.,anewdistributionsystem(sales↑addedtothenewproject)Negativesideeffects:coststootherprojects(erosionorcannibalism),e.g.,introductionofanewproductwillreducethesalesofexistingsimilarproducts(sales↓deductedfromthenewproject)10
TypesofCashFlowEffectsChangesinnetworkingcapital(NWC)relevantCurrentassets↑:requirecash,e.g.,inventory↑tosupportnewoperations,andaccountsreceivable↑asaresultofnewoperationsCurrent

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