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LECTURES SO FAR…WEEKS 4-5
Evaluation: Quantitative Analysis
Step 1: Forecast cash flows
•
Free cash flows not accounting income
•
Incremental cash flows
•
Consistency principle – Inflation & Taxation
Consistency principle
Inflation & Taxation
Step 2: Determine risk of cash flows
Step 3: Apply evaluation method
•
NPV, PI, IRR, MIRR, Payback, Discounted Payback, AAR
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FINS1613_s2_2010_L6
FINS1613
BUSINESS FINANCE
Lecture 6:
Capital Budgeting Applications II
Readings:
RTBWJ Chapter 9
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FINS1613_s2_2010_L6
LECTURE 6: LEARNING OBJECTIVES
Understand how to quantitatively analyse different types
of capital budgeting projects.
Understand the qualitative aspects of evaluating capital
budgeting projects.
Understand how to incorporate cash flow risk in capital
budgeting.
Understand how to incorporate real options into capital
budgeting.
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FINS1613_s2_2010_L6
EVALUATING A PROJECT
Steps in Evaluation using
NPV
:
1.
Forecast cash flows
2.
Estimate the opportunity cost of capital
3.
Discount future cash flows by the opportunity cost of capital
4.
Accept/reject the project based on whether NPV is
positive/negative
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FINS1613_s2_2010_L6
EVALUATING A PROJECT
Forecasted cash flows can be split into 3 areas:
1.
Initial investment outlay
: the up-front cost of the project plus any
increases in net operating working capital
2.
Operating cash flows &
∆
NWC
: incremental cash flows over the
project’s economic life.
3.
Terminal cash flows
: cash flows which occur at the end of a
project’s life
other than the operating cash flows e.g. salvage
value of fixed assets (adjusted for tax if necessary) and returned
net operating working capital
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FINS1613_s2_2010_L6
EVALUATING A PROJECT
The net cash flows in each year of the project are
determined as the sum of the cash flows in each of the
areas above.
These annual net cash flows are then used in the NPV
calculation.
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FINS1613_s2_2010_L6

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