Lecture_Week_06_6slides - LECTURES SO FARWEEKS 4-5...

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1 Australian School of Business FINS1613 Business Finance Lecturer: Anh Tu Le LECTURES SO FAR…WEEKS 4-5 b Evaluation: Quantitative Analysis Step 1: Forecast cash flows b Free cash flows not accounting income b Incremental cash flows b Step 2: Determine risk of cash flows Step 3: Apply evaluation method b NPV, PI, IRR, MIRR, Payback, Discounted Payback, AAR 2 FINS1613 – Semester 2, 2011 Lecture 6: Capital Budgeting Applications II Lecturer: Anh Tu Le Readings: RTBWJ Chapters 9 LECTURE 6: LEARNING OBJECTIVES b Understand how to quantitatively analyse different types of capital budgeting projects. b Understand the qualitative aspects of evaluating capital budgeting projects. b Understand how to incorporate cash flow risk in capital budgeting. b Understand how to incorporate real options into capital budgeting. 4 FINS1613 – Semester 2, 2011 EVALUATING A PROJECT b 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 5 FINS1613 – Semester 2, 2011 EVALUATING A PROJECT b 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. : 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 6 FINS1613 – Semester 2, 2011
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2 EVALUATING A PROJECT b 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. b These annual net cash flows are then used in the NPV calculation. 7 FINS1613 – Semester 2, 2011 EVALUATING AN EXPANSION PROJECT : AN EXAMPLE b Consider an expansion project s An expansion project uses new assets to increase sales. Hence the incremental cash flows are the in-flows and out-flows the project creates. b Need to have detailed forecasts of all relevant cash flows. 8 FINS1613 – Semester 2, 2011 EVALUATING AN EXPANSION PROJECT : AN EXAMPLE b A firm wishes to expand by producing solar-powered toy racing cars. s A new factory will be built. s New machinery will need to be purchased. s The project will produce/sell the cars for 4 years after which the factory and machinery will be sold. 9 FINS1613 – Semester 2, 2011 EVALUATING AN EXPANSION PROJECT : AN EXAMPLE b The following are project’s forecasted cash flows (t=0): b The no. of units sold will increase by 2000 each year until the end of the project without increases in prices/costs. For simplicity,
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This note was uploaded on 10/20/2011 for the course COMMERCE 3502 taught by Professor All during the One '11 term at University of New South Wales.

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Lecture_Week_06_6slides - LECTURES SO FARWEEKS 4-5...

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