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MGT160+Slides+-+Week+4-1

# MGT160+Slides+-+Week+4-1 - MGT160 Week 4 Review Chapter 8...

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1-1 MGT160 Week 4 – Review – Chapter 8 We will cover chapters 6 and 7 in Week 8 Mid T R i – Mid-Term Review Capital Budgeting Analysis of potential projects L t d i i Long-term decisions Large expenditures Difficult/impossible to reverse Determines firm’s strategic direction

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1-2 All cash flows considered? Good Decision Criteria • TVM considered? • Risk-adjusted? Ability to rank projects? Indicates added value to the firm? Net Present Value How much value is created from undertaking an investment? Step 1: Estimate the expected future cash flows. Step 2: Estimate the required return for projects of this risk level. Step 3: Find the present value of the cash flows and subtract the initial investment to arrive at the Net Present Value.
1-3 Net Present Value Sum of the PVs of all cash flows n CF Initial cost often is CF 0 and is an outflow. NPV = t = 0 t (1 + R) t NOTE: t=0 NPV = n t = 1 CF t (1 + R) t - CF 0 NPV – Decision Rule If NPV is positive, accept the project NPV > 0 means: – Project is expected to add value to the firm – Will increase the wealth of the owners NPV is a direct measure of how well this project will meet the goal of increasing shareholder wealth.

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1-4 Sample Project Data You are looking at a new project and have estimated the following cash flows, net income and book value data: – 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 See Handout Your required return for assets of this risk is 12%. This project will be the example for all problem exhibits in this chapter. Computing NPV for the Project Using the formula: = + = n 0 t t t ) R 1 ( CF NPV NPV = -165,000/(1.12) 0 + 63,120/(1.12) 1 + 70,800/(1.12) 2 + 91,080/(1.12) 3 = 12,627.41 U i E l Using Excel