Loading...

PPT – Capital Budgeting Techniques and Practice PowerPoint presentation | free to view - id: a8236-MDQzN

The Adobe Flash plugin is needed to view this content

View by Category

Presentations

Products
Sold on our sister site CrystalGraphics.com

About This Presentation

Write a Comment

User Comments (0)

Transcript and Presenter's Notes

Capital Budgeting Techniques and Practice

Chapter 9

Chapter Objectives

- Discuss why it is difficult to find profitable

projects - Use capital budget techniques to evaluate new

projects - Discuss Capital Rationing concerns
- Work through issues in Project rankings

Capital Budgeting

- Capital Budgeting is the process of decision

making with respect to investment in fixed assets

(long term projects) - Evaluation of the profitability of projects
- 4 methods (decision criteria) to evaluate

projects - Decide whether to accept or reject a project
- Projects are evaluated based on Free Cash Flows

Finding Profitable Projects

- Remember It is much easier to evaluate projects

than it is to find them - The curse of Competitive markets
- Finding profitable projects is essential for the

survival of the firm - How does a company find profitable projects?
- Typically, a firm has a research development

department that searches for ways of improving

existing products or finding new projects - Other sources?

Capital Budgeting Decision Criteria

- Payback Period
- Net Present Value
- Profitability Index (Benefit-Cost Ratio)
- Internal Rate of Return

Payback Period

- Number of years needed to recover the initial

cash outlay of a project - This criteria measures how quickly the project

will return its original investment - It is based on free cash flows, not accounting

profits - Emphasizes the early cash flows, which are less

uncertain than later cash flows

Payback Period Examples

Payback Period

- Strengths
- Simple to use, easy to understand
- Focuses on free cash flows, not accounting

profits - Useful as a control for risk (since it emphasizes

early cash flows) - Drawbacks
- Ignores Time Value of Money
- Ignores Cash Flows beyond payback period,

decision may be inconsistent with goal of the

firm - No objective decision rule (accept / reject)

Net Present Value or NPV

- Present value of the free cash flows less the

initial outlay - Gives a measurement of the net value of a project

in todays dollars - Decision Criteria
- If NPV 0, Accept the project
- If NPV lt 0, Reject the project

Discount Rate

- Cost of Capital (more in Chapter 11)
- Rate of Return necessary to justify raising funds

to finance the project - Required Rate of Return
- Rate of Return necessary to maintain the firms

current market price per share - Only NPV positive projects increase share prices

in the long run

NPV Example

- Project Initial Outlay 10,000
- Cash flows is 2,500 a year for 6 years
- Required rate of return 10
- PV of 2,500, 6 years, 10 is 10,888
- NPV of the project 10,888 - 10,000
- 888
- Decision Since 888 gt 0, Accept

Net Present Value

- Advantages
- Examines cash flows, not profits
- Recognizes time value of money
- By accepting only positive NPV projects, decision

criteria leads to increases value of the firm,

consistent with objective of firm - Disadvantages
- Need for detailed, long term forecasts

Profitability Index

- Also know as the Benefit-Cost ratio
- Ratio of the present value of the future free

cash flows to the initial outlay - Generates same results as NPV
- Under no capital rationing constraints
- Decision Criteria
- PI 1 Accept the project
- PI lt 1 Reject the project

Profitability Index Example

- Project Initial Outlay 10,000
- Cash flows 2,500 for 6 years
- Required rate of return 10
- PV of the cash flows 10,888
- PI 10,888/10,000 1.088
- Decision Since 1.088 gt 1 , Accept

NPV and PI Compared

- When the present value of a projects cash flows

are greater than the initial cash outlay - The Project NPV will be positive.
- The Project PI will be greater than 1.
- NPV and PI will always yield the same decision,

but does not necessarily rank acceptable projects

in the same order - Important distinction when there is capital

rationing or projects are mutually exclusive - PI has same advantages/disadvantages as NPV

Internal Rate of Return or IRR

- Defined as the discount rate that equates the

present value of a projects cash flows with the

projects Initial cash outlay - Answers the question What Rate of Return does

this project earn? - Decision Criteria
- If IRR gt Required rate of return, Accept
- IF IRR lt Required rate of return, Reject

IRR Example

- Project Initial Outlay 10,000
- Cash flows 2,500 for 6 years
- Required Rate of Return 10
- CFo -10,000
- C01 2,500
- F01 6
- IRR CPT
- True IRR 12.978 via financial calculator
- Decision Since IRR gt Required ROR, Accept

Internal Rate of Return

- Advantages
- Examines cash flows, not profits
- Recognizes time value of money
- Consistent with Goal of the Firm
- Rates are comparable across projects of different

sizes - Disadvantages
- Need for detailed, long term forecasts
- IRR may not exist for certain project that have

unconventional cash flows (more than one sign

change)

IRR and NPV Compared

- If NPV is positive, IRR will be greater than the

required rate of return - If NPV is negative, IRR will be less than

required rate of return - If NPV 0, IRR is the required rate of return
- NPV and IRR will yield the same decision, but

does not necessarily rank acceptable projects in

the same order - Important distinction when there is capital

rationing or when projects are mutually exclusive

NPV and IRR Compared

(No Transcript)

Capital Rationing

- Firm may place a limit on the dollar size of the

capital budget - Have to choose among the pool of accepted

projects - Potential Reasons
- Management may think market conditions are

temporarily adverse (Recessions) - Shortage of qualified managers
- Intangible considerations
- Risk aversion to debt
- Rejecting projects because of capital rationing

is contrary to the goal of the firm

Project Selection under Capital Rationing

- Selection Criteria Select the set of projects

with the highest NPV subject to the capital

constraint - Using this criteria, the result is that projects

that increase shareholder wealth the most will be

selected, since NPV is the amount of wealth that

is created when a project is selected

Capital Rationing Example

- Consider a 1 million dollar budget constraint
- Select projects A and C
- (Total outlay 200,000 800,000 1 million)
- These projects maximizes the firms NPV subject

to the capital constraint

Mutually Exclusive Projects

- Occur when two or more projects perform

essentially the same task - Different alternatives are available, but only

one can be used accomplish the task - Acceptance of one project will necessarily mean

rejection of the other project(s) - Example
- Installation of computer system
- Need to rank projects in order to select one

project, then Ranking Problems become important - The problem is how to choose from the pool of

accepted projects

Size Disparity Example

Ranking Problems Size Disparity

- Mutually Exclusive projects of unequal sizes are

examined - Initial cash outlay are different between the

alternative projects - Without Capital Rationing
- Choose the project with the largest NPV
- With Capital Rationing
- Select the project with the largest NPV that will

fit under the capital constraint

Time Disparity Example

Ranking Problems Time Disparity

- Future CF timing differences result in time

disparity - Time disparity of cash flows produce conflicting

rankings between NPV and IRR methods that result

from the differing reinvestment assumptions made

by the NPV and the IRR - NPV criterion assumes cash flows are reinvested

at the required rate of return - IRR criterion assumes cash flows are reinvested

at the IRR - NPV criterion preferred since it is more

conservative assumption, since the required rate

of return is the lowest possible reinvestment rate

Unequal Lives Ranking Problem

Ranking Problems Unequal Lives

- Mutually Exclusive Projects with different life

spans - Decision is difficult since the projects are not

comparable - Two methods to deal with the problem
- Replacement Chains
- Equivalent Annual Annuity

About PowerShow.com

You can use PowerShow.com to find and download example online PowerPoint ppt presentations on just about any topic you can imagine so you can learn how to improve your own slides and presentations for free. Or use it to find and download high-quality how-to PowerPoint ppt presentations with illustrated or animated slides that will teach you how to do something new, also for free. Or use it to upload your own PowerPoint slides so you can share them with your teachers, class, students, bosses, employees, customers, potential investors or the world. Or use it to create really cool photo slideshows - with 2D and 3D transitions, animation, and your choice of music - that you can share with your Facebook friends or Google+ circles. That's all free as well!

For a small fee you can get the industry's best online privacy or publicly promote your presentations and slide shows with top rankings. But aside from that it's free. We'll even convert your presentations and slide shows into the universal Flash format with all their original multimedia glory, including animation, 2D and 3D transition effects, embedded music or other audio, or even video embedded in slides. All for free. Most of the presentations and slideshows on PowerShow.com are free to view, many are even free to download. (You can choose whether to allow people to download your original PowerPoint presentations and photo slideshows for a fee or free or not at all.) Check out PowerShow.com today - for FREE. There is truly something for everyone!

presentations for free. Or use it to find and download high-quality how-to PowerPoint ppt presentations with illustrated or animated slides that will teach you how to do something new, also for free. Or use it to upload your own PowerPoint slides so you can share them with your teachers, class, students, bosses, employees, customers, potential investors or the world. Or use it to create really cool photo slideshows - with 2D and 3D transitions, animation, and your choice of music - that you can share with your Facebook friends or Google+ circles. That's all free as well!

For a small fee you can get the industry's best online privacy or publicly promote your presentations and slide shows with top rankings. But aside from that it's free. We'll even convert your presentations and slide shows into the universal Flash format with all their original multimedia glory, including animation, 2D and 3D transition effects, embedded music or other audio, or even video embedded in slides. All for free. Most of the presentations and slideshows on PowerShow.com are free to view, many are even free to download. (You can choose whether to allow people to download your original PowerPoint presentations and photo slideshows for a fee or free or not at all.) Check out PowerShow.com today - for FREE. There is truly something for everyone!

For a small fee you can get the industry's best online privacy or publicly promote your presentations and slide shows with top rankings. But aside from that it's free. We'll even convert your presentations and slide shows into the universal Flash format with all their original multimedia glory, including animation, 2D and 3D transition effects, embedded music or other audio, or even video embedded in slides. All for free. Most of the presentations and slideshows on PowerShow.com are free to view, many are even free to download. (You can choose whether to allow people to download your original PowerPoint presentations and photo slideshows for a fee or free or not at all.) Check out PowerShow.com today - for FREE. There is truly something for everyone!

Recommended

«

/ »

Page of

«

/ »

Promoted Presentations

Related Presentations

Page of

Home About Us Terms and Conditions Privacy Policy Presentation Removal Request Contact Us Send Us Feedback

Copyright 2018 CrystalGraphics, Inc. — All rights Reserved. PowerShow.com is a trademark of CrystalGraphics, Inc.

Copyright 2018 CrystalGraphics, Inc. — All rights Reserved. PowerShow.com is a trademark of CrystalGraphics, Inc.

The PowerPoint PPT presentation: "Capital Budgeting Techniques and Practice" is the property of its rightful owner.

Do you have PowerPoint slides to share? If so, share your PPT presentation slides online with PowerShow.com. It's FREE!