...Capital Budgeting Analysis Amanda Kocanda, DeUndre’ Rushon, HuongTran,& Morgan Gibreal MBA 612, Financial Strategy October 28, 2014 Bellevue University Abstract Within this paper, an overview of the general capital budgeting process and how it is implemented within organizations is defined and reported. Key terms related to capital budgeting are also defined. Risk analysis based on the Net Present Value (NPV) is performed on the salvage values before and after sales tax values along with the different sale ranges. Keywords: NPV, NPV Profile, NPV, IRR, multiple IRRs, ranking conflict of NPV vs. IRR, payback period, profitability index, discount rate, cost of capital concept, cash flow analysis, cash flow timeline, conventional cash flow stream, non-conventional cash flow stream, sunk cost, opportunity cost, independent projects, mutually exclusive projects Overview of the Capital Budgeting Process Every business requires some source of funds to maintain operation and competitive advantages. Whether it’s a manufacturing or servicing firm, it requires financing. Financing sources can be obtained through debt, bond issuance, bank loan, equity, and issuance of preferred and/or common stock. The amount of debt and equity builds the firm's capital structure. The firm's corporate or business strategy is the proportion of capital structure it needs to finance its operation. The combination of debt and equity totals the cost of capital for the firm. The...
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...Search Bar (http://hwguiders.com/ ) Solutions Guide: 1. We focus on free cash flows rather than accounting profits because these are the flows that the firm receives and can reinvest. Only by examining cash flows are we able to correctly analyze the timing of the benefit or cost. Also, we are only interested in these cash flows on an after tax basis as only those flows are available to the shareholder. In addition, it is only the incremental cash flows that interest us, because, looking at the project from the point of the company as a whole, the incremental cash flows are the marginal benefits from the project and, as such, are the increased value to the firm from accepting the project. 2. Although depreciation is not a cash flow item, it does affect the level of the differential cash flows over the project’s life because of its effect on taxes. Depreciation is an expense item and, the more depreciation incurred, the larger are expenses. Thus, accounting profits become lower and in turn, so do taxes which are a cash flow item. 3. When evaluating a capital budgeting proposal, sunk costs are ignored. We are interested in only the incremental after-tax cash flows, or free cash flows, to the company as a whole. Regardless of the decision made on the investment at hand, the sunk costs will have already occurred, which means these are not incremental cash flows. Hence, they are irrelevant. Solution to Integrative...
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...Super Project Tobey Overview • Case Summary • Problem Statement • ROFE & Capital Budgeting • Incredible Incremental • Analysis Options • Cash Flows • Recommendations Case Summary • General Foods is a large corporation organized by Product Lines. • Super is a proposed new instant desert, based on a “flavored, water-soluble, agglomerated powder.” • General Foods has numerous projects with strict criteria to judge worthiness. • There are basically three types of Capital Investment proposals at General Foods: Safety, Quality, Increased Profit • Increased Profit: Cost Reduction, Capacity, New Product • Max 10 years payback: as low as 20% PBT • … if expected to be permanent product addition • … if facilities highly reconfigurable • Three analysis types: Incremental, Facilities-based and Fully Allocated. Problem Statement • Above all, Super’s worthiness as a capital investment must be evaluated according to General Foods’ accepted criteria. • Memos indicate that General Foods’ finance personnel are questioning the same criteria’s ability to accurately reflect the value of the Super project. • This is not an accounting exercise. In accounting, one tries to track and attribute all sources of costs. Also, one alters transaction timings to match expenses with income. • This is a capital budgeting exercise. We’re interested in cash flows to judge the value of a project, and when those cash flows occur. • Therefore, our team must 1) evaluate the pertinence of each of the analysis...
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...Excellence in Financial Management Course 3: Capital Budgeting Analysis Prepared by: Matt H. Evans, CPA, CMA, CFM This course provides a concise overview of capital budgeting analysis. This course is recommended for 2 hours of Continuing Professional Education. In order to receive credit, you will need to pass a multiple choice exam which is administered over the internet at www.exinfm.com/training A companion toll free course can be accessed by dialing 1-877-689-4097, option 3, ID 752. Chapter 1 The Overall Process Capital Expenditures Whenever we make an expenditure that generates a cash flow benefit for more than one year, this is a capital expenditure. Examples include the purchase of new equipment, expansion of production facilities, buying another company, acquiring new technologies, launching a research & development program, etc., etc., etc. Capital expenditures often involve large cash outlays with major implications on the future values of the company. Additionally, once we commit to making a capital expenditure it is sometimes difficult to backout. Therefore, we need to carefully analyze and evaluate proposed capital expenditures. The Three Stages of Capital Budgeting Analysis Capital Budgeting Analysis is a process of evaluating how we invest in capital assets; i.e. assets that provide cash flow benefits for more than one year. We are trying to answer the following question: Will the future benefits of this project be large enough...
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...is free cash flow and how do I calculate it? A summary provided by Pamela Peterson Drake, Florida Atlantic University CONTENTS: Estimates of cash flows .................................................................................................................... 1 Free cash flow ................................................................................................................................. 2 Free cash flow and agency theory .................................................................................................. 3 Free cash flow to equity ................................................................................................................ 3 Free cash flow to the firm.............................................................................................................. 3 Valuation using free cash flow........................................................................................................... 4 Example.......................................................................................................................................... 5 Issues............................................................................................................................................. 6 Online resources for additional information on free cash flow............................................................... 6 The value of a company requires estimating future cash flows to providers of capital and capitalizing ...
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...Pittsburgh Capital Budgeting: Investment Criteria BUSFIN 1030 Introduction to Finance Capital Budgeting Decisions Examples of decisions addressed: 1. What products should the firm sell? 2. In what markets should the firm compete? 3. What new products should the firm introduce? Roles of managers: 4. Identify and invest in products and business acquisitions that will maximize the current market value of equity. 5. Learn to identify which products will succeed and which will fail. The capital markets will send the firm signals about how well it is doing. Net Present Value (NPV) The net present value is the difference between the market value of an investment and its cost. [pic] NPV is a measure of the amount of market value created by undertaking an investment project. The interest rate, r, will reflect the risk of the cash flows. Finding the market value of the investment 6. Use discounted cash flow valuation (calculate present values). 7. Compute the present values of future cash flows Net Present Value Rule (NPV): An investment should be accepted if the net present value is positive and rejected if the net present value is negative. Positive NPV projects create shareholder value. Using NPV The marketing department of your firm is considering whether to invest in a new product. The costs associated with introducing this new product and the expected cash flows over the next...
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...American Greetings and the analysis on the Company as an investment has been done with use of DCF model that uses the present value of the expected future cash-flows. In addition, the analysis has been done using the future cash-flows for the years 2012 to 2015. The company’s WACC has been established to be 0.11% given the risk-free rate of 0.05% and the Market rate of 11%. With that consideration, the enterprise values for the two scenarios including a bullish and bearish scenario have been calculated as $659.41 and $546.43 respectively, but which are identified as lower than the 2011 value of $714. However, the values still reflect a higher value for the company’s stock compared to the 2011 market price of $12.51. Thus, the company is undervalued by the market at the 2011 and has potential for a rise towards its fair price. In addition, the company has a relatively better credit rating by the credit rating agencies being an indication of its relative low risk. In conclusion, the company’s stock has been identified as a buy, and its fair price for the year 2011 has been estimated to be $18.64. American Greetings Analysis Company value depends on a number of factors. Those factors include the capital structure that determines its cost of resources as well as the market situation that defines its risk and future cash-flow prospects. On the other hand, investments’ valuation is crucial to decision making. In that respect, investors have a growing need to know the proposed of...
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...Excellence in Financial Management Course 3: Capital Budgeting Analysis Prepared by: Matt H. Evans, CPA, CMA, CFM This course provides a concise overview of capital budgeting analysis. This course is recommended for 2 hours of Continuing Professional Education. In order to receive credit, you will need to pass a multiple choice exam which is administered over the internet at www.exinfm.com/training A companion toll free course can be accessed by dialing 1-877-689-4097, option 3, ID 752. Chapter 1 The Overall Process Capital Expenditures Whenever we make an expenditure that generates a cash flow benefit for more than one year, this is a capital expenditure. Examples include the purchase of new equipment, expansion of production facilities, buying another company, acquiring new technologies, launching a research & development program, etc., etc., etc. Capital expenditures often involve large cash outlays with major implications on the future values of the company. Additionally, once we commit to making a capital expenditure it is sometimes difficult to backout. Therefore, we need to carefully analyze and evaluate proposed capital expenditures. The Three Stages of Capital Budgeting Analysis Capital Budgeting Analysis is a process of evaluating how we invest in capital assets; i.e. assets that provide cash flow benefits for more than one year. We are trying to answer the following question: Will the future benefits of this project be large enough to justify...
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...Valuation and Capital Budgeting Part I Capital Budgeting M. Lambert Valuation and Capital Budgeting Part I, HEC-ULg 2013-2014 – Marie Lambert 1 Real investments • Real investments are expenditures that generate cash in the future and, as opposed to financial investments, like stocks and bonds, are not financial instruments that trade in the financial markets • Corporations create value for their shareholders by making good real investment decisions Valuation and Capital Budgeting Part I, HEC-ULg 2013-2014 – Marie Lambert 2 Real investments • Intrinsic price of the project? - Financial managers should use a market-based approach to value assets, whether valuing financial assets, like stocks and bonds, or real assets, like factories and machines Valuation and Capital Budgeting Part I, HEC-ULg 2013-2014 – Marie Lambert 3 Module 1 Fundamentals of discounting Valuation and Capital Budgeting Part I, HEC-ULg 2013-2014 – Marie Lambert 4 Time-value-of-money concept • Relationship between $1 today and $1 in the future - Consider the following example: A firm is contemplating investing $1 million in a project that is expected to pay out $200,000 per year for 9 years. Should the firm accept the project? We need to know the relationship between a dollar today and a (possibly certain) dollar in the future before deciding on the project Valuation and Capital Budgeting Part I, HEC-ULg 2013-2014 – Marie Lambert 5 Time-value-of-money concept ...
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...MBA7001 Accounting for Decision-Makers Week 6 Lecture – Capital Investment Appraisal Slide 10.2 Chapter 10 Making capital investment decisions LEARNING OUTCOMES CHAPTER 10: Investment Appraisal Methods You should be able to: Explain the nature and importance of investment decision making First hour – 23.11.11 Identify the four main investment appraisal methods found in practice •Payback •ARR Use each method to reach a decision on a particular investment opportunity Discuss the attributes of each of the methods 1 Atrill and McLaney, Accounting and Finance for Non-Specialists, 7th Edition, © Pearson Education Limited 2011 Investment Appraisal Investment appraisal methods used in practice Investment appraisal – the process of appraising the potential investment projects. Assessment of the level of expected returns earned for the level of expenditure made. Estimates of future costs and benefits over the project’s life. 3 • Every business would like to do everything • But it all costs • Capital expenditure on new projects or purchases (fixed assets) needs to be planned • Capital is always rationed Scenario: • Your business wishes to expand its product line • It is considering Products A and B but it can only afford to do one. • How does it decide? What main factors affect the investment decision • How much will it cost ? Investment appraisal methods used in practice • How much will I get back ? • When will I get the income ? • 4 main techniques available ranging from ...
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...1. Discuss the difference between – State also advantages & disadvantages each: a. The payback period & the discounted payback period criteria of capital budgeting. The payback period measures the time that it takes to recoup the cost of the investment. If the cash flows are an annuity, then we can simply divide the cost by the annual cash flow to determine the payback period Otherwise, as in the example, we subtract the cash flows from the cost until the remainder is zero The shorter the payback period, the better Generally, firms will have some maximum allowable payback period against which all investments are compared Assume that your company is investigating a new labor-saving machine that will cost $10,000. The machine is expected to provide cost savings each year as shown in the following timeline: [pic] • If your required return is 12%, should this machine be purchased? For our example project, we will subtract the cash flows from the initial outlay until the entire cost is recovered: [pic] Since it will take 0.7143 years (= 2500/3500) to recover the last 2,500, the payback period must be 3.7143 years Advantages of Payback Period • It is easy to understand and apply. The concept of recovery is familiar to every decision-maker. • Business enterprises facing uncertainty - both of product and technology - will benefit by the use of payback period method since the stress in this technique is...
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...Chapter 11 The Basics of Capital Budgeting Integrated Case 11-24 Allied Components Company Basics of Capital Budgeting You recently went to work for Allied Components Company, a supplier of auto repair parts used in the after-market with products from Daimler, Chrysler, Ford, and other automakers. Your boss, the chief financial officer (CFO), has just handed you the estimated cash flows for two proposed projects. Project L involves adding a new item to the firm’s ignition system line; it would take some time to build up the market for this product, so the cash inflows would increase over time. Project S involves an add-on to an existing line, and its cash flows would decrease over time. Both projects have 3-year lives, because Allied is planning to introduce entirely new models after 3 years. Here are the projects’ net cash flows (in thousands of dollars): 0 1 2 3 | | | | Project L -100 10 60 80 Project S -100 70 50 20 Depreciation, salvage values, net working capital requirements, and tax effects are all included in these cash flows. The CFO also made subjective risk assessments of each project, and he concluded that both projects have risk characteristics that are similar to the firm’s average project. Allied’s WACC is 10%. You must determine whether one or both of the projects should be accepted. A. What is capital budgeting? Are there any similarities between a firm’s capital budgeting decisions and an individual’s investment decisions? ...
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...Project cash flow; accounting income b. Incremental cash flow; sunk cost; opportunity cost; externality; cannibalization; expansion project; replacement project c. Net operating working capital changes; salvage value d. Stand-alone risk; corporate (within-firm) risk; market (beta) risk e. Sensitivity analysis; scenario analysis; Monte Carlo simulation analysis. f. Risk-adjusted discount rate; project cost of capital g. Decision tree; staged decision-tree analysis; decision node; branch h. Real options; managerial options; strategic options; embedded options i. Investment timing option; growth option; abandonment option; flexibility option a. Project cash flow: The process of inflow or outflow of cash in any project is called cash flow. In project cash flow the increase in income results cash inflow on the other hand, expenditure results cash outflow. Accounting income: Accounting income is the result after deducting the total sales revenue from its expenses. The result of accounting income and cash flow differs in the financial statement because accounting income makes records of both cash and non cash transaction. While in cash flow only pure cash transaction are recorded. b) Incremental cash flow: Incremental cash flow is the additional cash that company may receive by taking a new project. If a company sees positive incremental of cash flow then it means the company can get additional cash flow in future, if new project is accepted. Sunk cost: The...
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...TABLE OF CONTENT ACKNOWLEDGEMENTS 2 1. COLEMAN SYSTEM BACKGROUND INFORMATION 4 2. COST OF CAPITAL FOR COLEMAN SYSTEMS 5 2.1 Calculate cost of debt (rd) 5 2.2 Calculate ratio debt/capital and equity/capital in market value terms 6 2.3 Calculate Beta (β) for Coleman Systems 8 2.4 Calculate Cost of Equity 10 2.5 Calculate the weighted average cost of capital for Coleman Systems 10 3. THE WACC AND PROJECT VALUES FOR DIFFERENT DEBT – EQUITY RATIOS AND THE OPTIMAL CAPITAL STRUCTURE FOR THE PROJECT 11 3.1 Case 1: No bankruptcy risk without tax 11 3.2 Case 2: No bankruptcy risk with tax 13 3.3 Case 3: With bankruptcy risk with tax 15 4. DISCUSSION ON AGENCY AND SIGNALLING EFFECT 18 5. REPLACEMENT PFOJECT 21 5.1 Replacing Machine A with Machine B 21 5.2 Replacing Machine A with Machine C 26 6. UNDERTAKE A SENSITIVITY ANALYSIS FOR THE TWO PROJECTS. 31 REFERENCES 34 SEMESTER 2013 CORPORATE FINANCE–BMCF5103 ASSIGNMENT (60%) 1. COLEMAN SYSTEM BACKGROUND INFORMATION Coleman Systems is a private manufacturing company that makes electrical components. We have the following information about Coleman, as well as three listed companies in the electronics industry. |Term |Coleman |Skye |Allied |Foust | |Book value of assets (£m) ...
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...Operating cash flows rather than accounting income are listed in your text. Why do we focus on cash flows as opposed to net income in capital budgeting? I believe in capital budgeting, Net income is considered apparent income (forecasted), whereas Cash flow is considered true income (current). We focus on cash flow because it is more important within capital budgeting because company’s need to know what they have currently to decide if they can or cannot invest in a proposed project. 2. What is the difference between cash flow and accounting income? The difference between the two is that Cash Flow is more critical because it lets a company know how much cash they have on-hand to pay for their expenses (creditors, employees, etc…) on time and to decide whether or not they should reinvest. 3. Explain why sunk costs should not be included in a capital budgeting analysis, but opportunity costs and externalities should be included? Give an example of each. Sunk Cost is defined as a cash outlay that has already been incurred and that cannot be recovered regardless of whether the project is accepted or rejected. It is cost that has been spent and does not give any support within the capital budgeting analysis. However, opportunity cost depicts what cash flows are needed to support the project and externalities display the side effects of cash flows a firm inherits by taking on a project (pg 403). Firms sunk cost gives no relevancy within the capital budgeting...
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