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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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•
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.

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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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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