2504c_1025 - BUSI 2504c - Essentials of Business Finance...

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BUSI 2504c - Essentials of Business Finance Monday, October 25, 2010 18:15-18:45 Quiz #3 §9 Capital Budgeting 3 rd hour (optional) midterm review
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announcements MIDTERM Saturday, October 30, 2010, 11:30-13:30, Minto 2000 chapters 1, 5, 6, 7 and 8 allowed your own single-sided notes/formula sheet on 8.5x11 paper which must be handwritten Texas Instruments BA II Plus (black or silver version) is only calculator allowed suggested exercises (with solutions) available at http://lemma.ca/2504c/midterm.html BUSI 2504c Monday, October 25, 2010 2 / 1
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chapter 9: capital budgeting §9.1 - Net Present Value §9.2 - Payback and Discounted Payback §9.3 - Average Accounting Return §9.4 - Internal Rate of Return §9.5 - Profitability Index §9.6 - Practice of Capital Budgeting BUSI 2504c Monday, October 25, 2010 3 / 1
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chapter 9: what is capital budgeting? method for evaluating investment opportunities long-term projects (lasting more than one year) also known as capital expenditures (capex) cash flows year 0 - initial or "startup" costs, eg. purchase of machinery years 1, 2, . .. - incremental revenues (inflow) years 1, 2, . .. - operating costs, salaries, maintenance, . .. (outflow) salvage value (inflow) capital rationing (limited capital to invest) rank investments based on NPV invest in projects until available capital exhausted BUSI 2504c Monday, October 25, 2010 4 / 1
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chapter 9: what makes a good decision criteria? We need to ask ourselves the following questions when evaluating decision criteria: Does the decision rule adjust for the time value of money? Does the decision rule adjust for risk? Does the decision rule provide information on whether we are creating value for the firm? BUSI 2504c Monday, October 25, 2010 5 / 1
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chapter 9: project example information You are looking at a new project and you have estimated the following cash flows: Year 0: CF = -165,000 Year 1: CF = 63,120; NI = 13,620 Year 2: CF = 70,800; NI = 3,300 Year 3: CF = 91,080; NI = 29,100 Average Book Value = 72,000 Your required return for assets of this risk is 12%. BUSI 2504c Monday, October 25, 2010 6 / 1
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9.1: net present value (npv) The difference between the market value of a project and its cost How much value is created from undertaking an investment? The first step is to estimate the expected future cash flows The second step is to estimate the required return for projects of this risk level The third step is to find the present value of the cash flows and subtract the initial investment BUSI 2504c Monday, October 25, 2010 7 / 1
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9.1: npv - decision rule If the NPV is positive, accept the project A positive NPV means that the project is expected to add value to the firm and will therefore increase the wealth of the owners Since our goal is to increase owner wealth, NPV is a direct measure of how well this project will meet our goal BUSI 2504c Monday, October 25, 2010 8 / 1
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9.1: computing npv for the project Using the BA II Plus calculator: CF 0 = - 165 , 000 ENTER ; C01 = 63 , 120 ENTER ; F01 = 1 ; C02 = 70 , 800 ENTER ; F02 = 1 ; C03 = 91 , 080 ENTER ; F03 = 1 ; NPV ; I = 12 ENTER ; CPT ; NPV = 12,627.41 Do we accept or reject the project?
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2504c_1025 - BUSI 2504c - Essentials of Business Finance...

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