_4 NPV & Other Techniques - Lecture 4 NPV Other Techniques Major Topics The following topics will be discussed in this lecture Concepts of

_4 NPV & Other Techniques - Lecture 4 NPV Other...

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Lecture 4 NPV & Other Techniques
Major Topics The following topics will be discussed in this lecture : Concepts of Capital Budgeting. Major investment criteria, including : Net Present Value Payback Rule Average Accounting Return Rule Internal Rate of Return Profitability Index Non-conventional Cash Flows & Mutually Exclusive Projects Modified Internal Rate of Return 2
Capital Budgeting It is the process of decision making with respect to investments in fixed assets. It helps to consider whether we should accept or reject a proposed project. Projects may originate from : Within the firm Other sources 3
Capital Budgeting Within the firm : Research & Development (R&D) Department of a firm will search for ways of improving existing products or finding new projects. Other Sources : Projects may come from the needs to tackle competitions, from demand of suppliers, or usually from the pressure from customers. 4
Capital Budgeting Decision Criteria Capital budgeting focuses on free cash flows, which are the benefits generated from accepting a capital-budgeting proposal. Based on these free cash flows, we have some commonly used criteria for determining the acceptability of investment proposals or projects. Net Present Value (NPV) Payback Rule Average Accounting Return (AAR) Profitability Index Internal Rate of Return (IRR) 5
Capital Budgeting Decision Criteria Before we discuss the details, please note that when we are evaluating these decision criteria, we need to consider a number of factors : Adjustments for Time Value of Money. Adjustments for Risk. Value Creation for the firm. 6
Background Information Before illustrating different decision criteria, here are the background information of a new project. Your required return for projects of similar risk is 12% p.a. 7 Year Cash Flow $ Net Income $ 0 -165,000 1 63,120 13,620 2 70,800 3,300 3 91,080 29,100 Average Book Value = $72,000
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Net Present Value (NPV) NPV = PV – Required Investment NPV C C r t t = + + 0 1 ( ) NPV C C r C r C r t t = + + + + + + + 0 1 1 2 2 1 1 1 ( ) ( ) ... ( ) 10

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