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FM11_Ch_10_Tool_Kit - 6 7 8 9 10 11 12 13 14 15 16 17 18 19...

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Ch 10 To l Kit 6/7/20 3 Chapter 10. To l Kit for The Basics of Capital Budgeting: Evaluating Cash Flows Expected after-tax Project S Year (t) Project S Project L 0 1 2 3 4 0 ($1,0 0) ($1,0 0) (1,0 0) 50 40 30 10 1 2 Project L 3 4 60 0 1 2 3 4 (1,0 0) Capital Budgeting Decision Criteria Payback Period Project S Time period: 0 1 2 3 4 Cash flow: (1,0 0) Cumulative cash flow: (1,0 0) (50 ) (10 ) 20 Click fx > Logical > AND > OK to get dialog box. 0.0 1.0 0.0 Use Logical "AND" to determineThen specify you want TRUE if cumulative CF > 0 but the previous CF < 0. 2.3 the first positive cumulative CFThere wil be one TRUE. Payback: 2.3 Use Logical IF to find the PaybacClick fx > Logical > IF > OK. Specify that if true, the payback is the previous year plus a fraction, if false, then 0. Use Statistical Max function to Click fx > Statistical > MAX > OK > and specify range to find Payback. Alternative calculation 2.3 display payback. Project L Time period: 0 1 2 3 4 Cash flow: (1,0 0) Cumulative cash flow: (1,0 0) (90 ) (60 ) (20 ) Payback: 3.3 Uses IF statement. Discounted Payback Period WAC = 10% Project S Time period: 0 1 2 3 4 Cash flow: (1,0 0) Disc. cash flow: (1,0 0) 45 3 1 2 5 68 Cash Flows Discounted back at 10%. Disc. cum. cash flow: (1,0 0) (545) (215) 1 79 Discounted Payback: 2.95 Uses IF statement. Project L Time period: 0 1 2 3 4 Cash flow: (1,0 0) Disc. cash flow: (1,0 0) 91 248 301 410 Disc. cum. cash flow: (1,0 0) (909) (6 1) (361) 49 Discounted Payback: 3.8 Uses IF statement. Net Present Value (NPV) = 10% Project S Time period: 0 1 2 3 4 Cash flow: (1,0 0) Disc. cash flow: (1,0 0) 3 1 2 5 68 NPV(S) = $78.82 = Sum disc. CF's. or $78.82 = Uses NPV function. Project L Time period: 0 1 2 3 4 Cash flow: (1,0 0) Disc. cash flow: (1,0 0) 91 248 301 410 NPV(L) = $49.18 $49.18 = Uses NPV function. Internal Rate of Return (IR ) Expected after-tax Year (t) Project S Project L 0 ($1,0 0) ($1,0 0) The IR function as umes 1 14.49% payments oc ur at end of 2 1 .79% periods, so that function does 3 not have to be adjusted. 4 Multiple IR 's Consider the case of Project M. Project M: 0 1 2 (1.6) 10 (10) 25.0% 40 % Project M: 0 1 2 (1.6) 10 (10) r = 25.0% NPV = NPV r $0.0 0% (1.60) 25% 50% 0.62 75% 0.85 10 % 0.90 Max. 125% 0.87 150% 0.80 175% 0.71 20 % 0.62 2 5% 0.53 250% 0.4 275% 0.36 30 % 0.28 325% 0.20 350% 0.13 375% 0.06 40 % 425% (0.06) 450% (0.1 ) 475% (0.16) 50 % (0.21) 525% (0.26) 5 0% (0.30) NPV Profiles Net Cash Flows Year Project S Project L = 10.0% 0 -$1,0 0 -$1,0 0 Project S Project L 1 $50 $10 NPV = $78.82 $49.18 2 $40 $30 IR = 14.49% 1 .79% 3 $30 $40 Cros over 7.17% 4 $10 $60 Data Table used to make graph: Project NPVs S L WAC $78.82 $49.18 0% $30 .0 $40 .0 5% $180.42 $206.50 7.17% $134.40 $134.40 10% $78.82 $49.18 1 .79% $46.10 $0.0 14.49% $0.0 -$68.02 15.0% -$8.3 -$80.14 20% -$83.72 -$187.50 25% -$149.4 -$27 .4 Points about the graphs: 1. In Panel a, we se that if WAC < IR , then NPV > 0, and vice versa. 2. Thus, for "normal and independent" projects, there can be no conflict betwe n NPV and IR rankings. 4. Summary: a. For normal, independent projects, conflicts can never oc ur, so either method can be used. b. For mutual y exclusive projects, if WAC > Cros over, no conflict, but if WAC < Cros over, then there wil be a conflict betwe n NPV and IR . Expected after-tax Cash flow Alternative: Use To ls > Goal Se k to find WAC when NPV(S) = Year (t) Project S Project L dif erential NPV(L). Set up a table to show the dif erence in NPV's, which we 0 ($1,0 0) ($1,0 0) 0 want to be zero. The fol owing wil do it, get ing WAC = 7.17%.
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