11 Chapter Model

11 Chapter Model - 11 Chapter model 3/22/10 7:08 AM...

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11 Chapter model 3/22/10 7:08 AM 2/15/2006 Chapter 11. The Basics of Capital Budgeting Figure 11-1 Net Cash Flows for Projects S and L Year (t) Project S Project L 0 $(1,000) $(1,000) (Initial cost in Year 1) 1 500 100 2 400 300 3 300 400 4 100 675 0 1 2 3 4 Project S | | | | | -$1,000 $500 $400 $300 $100 0 1 2 3 4 Project L | | | | | -$1,000 $100 $300 $400 $675 We used this model to create most of the chapter exhibits (Tables and Figures). We pasted in a few dialog boxes for specific Excel functions and features and show them off to the right of where they apply, but in general we encourage students who want to know more about Excel to use the Excel Tutorial and refer to it as necessary. We also like to let students know that Excel models can be used to create tables and graphs that can then be copied into Word documents, which is the way we prepared the text manuscript for submission to the publisher. That procedure is used often in business to prepare reports. Although we did not create the model for use in lectures, it could be used as such in a classroom where a projector is attached to a computer. The instructor could scroll through the model and lecture on points as they come up. This would be more useful if the students have some familiarity with Excel, but that is not really necessary because everything the model does can also be done with a financial calculator. NET PRESENT VALUE & INTERNAL RATE OF RETURN The Net Present Value (NPV) method estimates how much a potential project contributes to shareholder wealth and is the primary capital budgeting decision criterion. While other capital budgeting tools are important and provide valuable information, the NPV is clearly the dominant metric used to evaluate projects. We use cash flow data for two projects (S and L) to illustrate NPV concepts and calculate NPV and IRR. Project S's cash flows come in sooner than L’s. We assume that the projects are equally risky and that the end-of-year net cash flows have been adjusted to reflect taxes, depreciation, and salvage values. Expected After-Tax Net Cash Flows, CFt
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NPV and IRR Calculations for Projects S and L Year (t) Project S Project L 0 $(1,000) $(1,000) (Initial cost in Year 1) 1 500 100 2 400 300 3 300 400 4 100 675 WACC = 10% Project S 0 1 2 3 4 | | | | | -$1,000 $500 $400 $300 $100 $454.55 $330.58 $225.39 $68.30 NPV = $78.82 14.49% Using Excel's NPV function: NPV = $78.82 Using Excel's IRR function: IRR = 14.49% Project L 0 1 2 3 4 | | | | | -$1,000 $100 $300 $400 $675 $90.91 $247.93 $300.53 $461.03 NPV = $100.40 13.55% Using Excel's NPV function: NPV = $100.40 Using Excel's IRR function: IRR = 13.55% These cash flows (either in table or time line form) can be used to quickly solve for NPV by finding the PV of each cash flow, or by using the NPV function. To find the internal rate of return, you must use Excel's IRR function. Expected After-Tax Net
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11 Chapter Model - 11 Chapter model 3/22/10 7:08 AM...

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