lecture_24_project_eval (1)

# lecture_24_project_eval (1) - MA826 FINANCE AND FINANCIAL...

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MA826 FINANCE AND FINANCIAL REPORTING 24 - Capital Project Appraisal A capital project involves initial expenditure followed by a stream of revenues and running costs when the project becomes operational. Capital projects need to undergo an initial appraisal. why?

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criteria? Mainly in terms of risk and returns on the project, including: Extent of synergy with other projects the company has undertaken. Satisfying the constraints within and without. Extent of upside potential. Use of financial or management resources in the best way.
Methods of Evaluation 1. Net present value NPV 2. Internal rate of return IRR but also: 3. Annual capital charge 4. Shareholder value approach 5. Payback period 6. Opportunity cost 7. Nominal returns 8. Strategic fit

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Methods of Evaluating Risky Projects 1. Sensitivity analysis 2. Scenario testing 3. Simulation 4. Probability trees 5. Certainty equivalents
In evaluating a project, we need to Define the project Evaluate the most likely cash flows. Decide what these cash flows consist of Calculate the financial result Costs Benefits

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Methods of Project Evaluation 1. Net Present Value- NPV C 1, C 2 , …, C n n project's returns The present value of cash flow: C 1 C 2 C n PV = + + … + (1+r) (1+r) 2 (1+r) n GPV If C 0 is the initial capital investment
NPV is: C 1 C 2 C n NPV = + +…+ - C 0 (1+r) (1+r) 2 (1+r) n NPV is calculated with r = hurdle rate Hurdle rate > = cost of capital The decision rule : Outcome Decision NPV > 0 Accept: hurdle rate is met NPV < 0 Reject NPV = 0 Inconclusive

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Example Year Cash Flow 1/(1+0.1) n PV £ £ 0 -2200 1 -2200 1 770 0.909 700 2 968 0.8264 800 3 1331 0.751 1000 NPV = + 300 NPV calculated @ discount rate of 10% If discount rate =20% , NPV = -115.93
Profitability Index = PV/C 0 If index > 1 Accept Example: profitability index of the project = 2461/2200 = 1.12 Internal Rate of Return- IRR IRR of a project is the discount rate when NPV=0 Decision rule Outcome Decision IRR > cost of capital Accept IRR < Reject IRR = Inconclusive

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NPV
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## This note was uploaded on 06/07/2011 for the course MA 826 taught by Professor Loba,millet during the Spring '11 term at Kent Uni..

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lecture_24_project_eval (1) - MA826 FINANCE AND FINANCIAL...

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