EFN406 Lecture 04 2009 - EFN406 Managerial Finance Topic 4...

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EFN406 Managerial Finance EFN406 Managerial Finance Topic 4 Topic 4 Introduction to Capital Budgeting Investment Evaluation Techniques
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2009 EFN406 Managerial Finance Slide2 Reading Reading Lecture Notes PBEHP Chapter 5, Project Evaluation: Principles and Methods Preview the first few pages of Chapter 6
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2009 EFN406 Managerial Finance Slide3 Outline Outline The Nature of Capital Budgeting Types of project The Investment Decision Model DCF methods Non-DCF Methods Evaluation of the Methods
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2009 EFN406 Managerial Finance Slide4 Capital Budgeting Process Capital Budgeting Process Generation of investment proposals Evaluation and selection (forward) Approval and control of capital expenditure Post-completion audit (forward & backward)
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2009 EFN406 Managerial Finance Slide5 Types of Project Types of Project Independent Mutually Exclusive Physical constraint Financial constraint Unless otherwise stated in this course we are referring to physical constraints (see section 6.8 of the textbook for analysis under financial constraints)
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2009 EFN406 Managerial Finance Slide6 Methods of Project Evaluation Methods of Project Evaluation Non-Discounting Methods Accounting Rate of Return Payback Period Discounting Methods Net Present Value Internal Rate of Return Profitability Index Annual Equivalents Each has its variations
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2009 EFN406 Managerial Finance Slide7 The NPV Rule The NPV Rule The net present value of a project is given by deducting the outlay (investment) from the present value of the future cash flows. In a multi-period framework this is given by the following: = + + - = 1 0 ) 1 ( t t t k X I NPV Note the timing convention used is 0,1,2, .............
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2009 EFN406 Managerial Finance Slide8 Non-DCF Methods Non-DCF Methods Payback Accounting Rate of Return These methods do not explicitly involve discounting procedures - they ignore time value of money Fairly widely used in practice Not consistent with objective of the firm
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2009 EFN406 Managerial Finance Slide9 Payback [PB], Payback Reciprocal [PBR] Payback [PB], Payback Reciprocal [PBR] and Discounted Payback [DPB] and Discounted Payback [DPB] [PB] and [PBR] simple - common It is the time it takes the project’s cash flows to pay back its initial investment normally use net cash flows Decision rule: if payback is less than target accept project, if more then reject.
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