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Unformatted text preview: 11MGT160 Week 4 Review Chapter 8 We will cover chapters 6 and 7 in Week 8 MidTerm ReviewCapital Budgeting Analysis of potential projects Longterm decisions Large expenditures Difficult/impossible to reverse Determines firms strategic direction12 All cash flows considered?Good Decision Criteria TVM considered? Riskadjusted? Ability to rank projects? Indicates added value to the firm?Net Present ValueHow much value is created from undertaking an investment?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.13Net Present Value Sum of the PVs of all cash flowsnCFInitial cost often is CFand is an outflow.NPV =t = 0CFt(1 + R)tNOTE: t=0NPV =nt = 1CFt(1 + R)t CFNPV Decision RuleIf 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.14Sample 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 = 29,100See 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:=+=ntt)R1(CFNPVNPV = 165,000/(1.12)+ 63,120/(1.12)1+ 70,800/(1.12)2+ 91,080/(1.12)3= 12,627.41=t Using Excel15DisplayYou Enter'Cash Flows:Computing NPV for the ProjectUsing the TI BAII+ CF Worksheet'C00165000 S!#C0163120!#F01 1 !#C0270800!#F021 !#C0391080!#F031!#(CF0= 165000CF1= 63120CF2= 70800CF3= 91080F031 !#(I12 !#NPV%12,627.41Net Present Value Sum of the PVs of all cash flows.nCF=+=ttt)R1(CFNPV<< CALCULATORnCF<< EXCEL1tttCF)R1(CFNPV+==16Rationale for the NPV Method NPV = PV inflows Cost NPV=0 Projects inflows are exactly sufficient to repay the invested capital and provide the required rate of return NPV = net gain in shareholder wealthRule: Accept project if NPV > 0NPV MethodMeets all desirable criteriaConsiders all CFs Considers all CFs Considers TVM Adjusts for risk Can rank mutually exclusive projectsDirectly related to increase in VDirectly related to increase in VFDominant method; always prevails17Payback Period How long does it take to recover the initial cost of a project?...
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 Fall '08
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