AGB 310 Lec 4 NPV

AGB 310 Lec 4 NPV - 10 - 1 The Basics of Capital Budgeting...

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10 - 1 The Basics of Capital Budgeting Overview and “vocabulary” Methods Payback NPV IRR, MIRR Unequal lives Economic life 10 - 2 What is capital budgeting? Analysis of potential projects. Long-term decisions; involve large expenditures. Very important to firm’s future.
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10 - 3 Steps in Capital Budgeting Estimate cash flows (inflows & outflows). Assess risk of cash flows. Determine r = WACC for project. Evaluate cash flows. 10 - 4 Independent vs mutually exclusive projects Projects are independent when cash flows of one are unaffected by the acceptance of the other. Projects are mutually exclusive if the cash flows of one can be adversely impacted by the acceptance of the other.
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10 - 5 The payback period The number of years required to recover a project’s cost. How long does it take to get the business’s money back? 10 - 6 Payback for Franchise Long 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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10 - 7 Franchise Short 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 = 10 - 8 Strengths of Pay Back provides an indication of a project’s risk and liquidity. easy to calculate and understand. Weaknesses of Pay Back ignores the TVM. ignores CFs occurring after the payback period. Franchise Short
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10 - 9 NPV is the sum of PVs of all inflows and outflows generated by project. Cost at CF 0 is negative. Net Present Value (NPV) 10 - 10 Franchise L’s NPV 10 80 60 0 1 2 3 i = 10% Project L: -100.00 9.09 49.59 60.11 18.79 = NPV L NPV S = $19.98.
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Calculator Solution for NPV Enter in CFs for L: -100 10 60 80 10 CF 0 CF 1 NPV CF 2 CF 3 I = 18.78 = NPV L 10 - 12 Rationale for the NPV Method NPV = PV inflows - Cost = Net gain in wealth Accept project if NPV is positive. Reject project if NPV is negative.
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This note was uploaded on 10/18/2009 for the course AGB 7510 taught by Professor Slezak during the Fall '09 term at Cal Poly.

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AGB 310 Lec 4 NPV - 10 - 1 The Basics of Capital Budgeting...

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