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Chapter 10 Financial Management

Chapter 10 Financial Management - Financial Management ADM...

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© 2007 Dr. William F. Rentz & Associates, All Rights Reserved 1 Financial Management ADM 2350 Professor: Dr. William F. Rentz
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© 2007 Dr. William F. Rentz & Associates, All Rights Reserved 2 Capital Budgeting Decisions Chapter 10 1. Decision Criteria 2. Capital Rationing 3. Unequal Lives 4. Further Post Audit Considerations 5. Real Options 6. International & Small Firm Considerations
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© 2007 Dr. William F. Rentz & Associates, All Rights Reserved 3 Introduction This chapter looks at capital budgeting decision models It discusses and illustrates the relative strengths and weaknesses of these models It looks at capital rationing and at projects with unequal lives
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© 2007 Dr. William F. Rentz & Associates, All Rights Reserved 4 Introduction This chapter examines project review and post-audit procedures It studies real options It considers some of the problems in making capital budgeting decisions in international and small firms
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© 2007 Dr. William F. Rentz & Associates, All Rights Reserved 5 Capital Budgeting Criteria Net present value (NPV) Profitability index (PI) Internal rate of return (IRR) Payback period (PB)
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© 2007 Dr. William F. Rentz & Associates, All Rights Reserved 6 Net Present Value PV of the stream of future CFs from a project minus the project’s net investment NINV PVNCF NPV - = ( 29 NINV NPV NCF - = = + n t k t t 1 1
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© 2007 Dr. William F. Rentz & Associates, All Rights Reserved 7 NPV for Beaver Brewing* *cash flows are from the previous lecture 963 , 13 $ 000 , 102 $ 957 , 45 $ 840 , 19 $ 240 , 22 $ 000 , 102 $ 25 . 1 760 , 89 $ 25 . 1 000 , 31 $ 25 . 1 800 , 27 $ 3 2 - = - + + = - + + = NPV NPV NPV
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© 2007 Dr. William F. Rentz & Associates, All Rights Reserved 8 NPV for Beaver Brewing NPV of bottling machine is NEGATIVE Beaver should NOT invest in this project
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© 2007 Dr. William F. Rentz & Associates, All Rights Reserved 9 NPV Characteristics NPV 0 acceptable above-normal profits Considers the time value of money Absolute measure of wealth Positive NPVs increase owner’s wealth Negative NPVs decrease owner’s wealth
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© 2007 Dr. William F. Rentz & Associates, All Rights Reserved 10 NPV Characteristics NPV not easily understood CFs over the project’s life reinvested at k Does not consider the value of real options
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© 2007 Dr. William F. Rentz & Associates, All Rights Reserved 11 Conditions Allowing Above- Normal Profits Buyers preferences for established brand names Control of distribution systems Patent control Exclusive ownership of superior natural resources
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© 2007 Dr. William F. Rentz & Associates, All Rights Reserved 12 Conditions Allowing Above- Normal Profits Inability of new firms to acquire factors of production Access to lower cost financial resources Economies of scale Access to superior labour or management talents
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© 2007 Dr. William F. Rentz & Associates, All Rights Reserved 13 Profitability Index Ratio of the PV of future cash flows over the life of the project to the NINV ( 29 NINV NCF PI = + = n t t k 1 1
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© 2007 Dr. William F. Rentz & Associates, All Rights Reserved 14 PI for Beaver Brewing 863 . 0
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