...accounting rate of return. In this paper, I will examine the use of the Net Present Value, and the provisions it makes for specific cases, such as unequal lives and mutually exclusive projects. Then I will conclude with the technique that has been proved the best for investment appraisal through the analysis and comparison of project appraisal techniques. The Net Present Value (NPV) method is used by 75% of firms when deciding on investment projects. The reasons for its wide use is that firstly, the NPV rule takes into account the time value of money, meaning that it recognises that a pound today is worth more than a pound tomorrow as the pound today can be invested to start earning interest immediately. Secondly, NPV depends solely on the forecasted cash flows from the project and the opportunity cost of capital. And the final reason for its preference is because the present values are all measured in today’s pounds they have the property of additivity. This property is important as it helps managers to not be misled into accepting a low NPV project just because it is packaged with a high NPV project (Brealey and Myers 116-19). Other reasons for this widely used...
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...Capital Budgeting Practices MGMT 640 Section 9040 Professor J.Jain Executive Summary This essay discusses the importance of capital budgeting and analyzes the most common techniques. The most frequently used methods are the net present value (NPV) and internal rate of return (IRR). These are both tools that analyze the present value of the cost of a project as well as the present value of that projects future cash flows. An essential part of these methods is that they both account for discounted cash flow (DCF), meaning that they both reflect the time value of money. When analyzing independent projects with conventional cash flows, both the NPV and IRR will provide projections along the same lines. However when those two conditions are not met, the IRR method will become misleading. Therefore I argue that the NPV should take precedence over the IRR when only one method can be chosen. However, financial managers should be wary when using the NPV as it does not account for certain factors such as the value of waiting and cash flows that occur on a non-yearly basis. There are direct correlations between the size of a firm and the capital budgeting method most utilized. Small businesses frequently overlook the two most popular methods and opt to analyze projects with the “payback period”, which evaluates the time it will take in order to recuperate cash flows invested in a given project. The variation of this method is known as the discounted payback period, which also accounts...
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...H00112703 INTERNATIONAL BUSINESS MANAGEMENT FRIDAY 08TH MARCH 2012 C38FN 2012-2013 CORPORATE FINANCIAL THEORY WORDCOUNT: 2874 Abstract This essay will discuss the net present value (NPV), payback period (PBP) and internal rate of return (IRR) approaches for a project evaluation. It is often said that NPV is the best approach investment appraisal, which I why I will compare the strengths and weaknesses of NPV as well as the two others to se if the statement is actually true. Introduction To start of, the essay will attempt to explain the theoretical rationale of the net present value approach to investment appraisal as well as its strengths and weaknesses. From there, introduce the payback period method and then internal rate of return approach, as well as to consider their strengths and weaknesses. After outlining and explaining the three different approaches, it will finish up with comparing the different three and in a conclusion. NPV Net present value or NPV is an approach used to determine the value of an investment today (present) compared to the value of the investment in the future after taking the inflation and return into account. In simpler words, it compares the value of 1 pound today with the same pound in the future. Net present value is used in capital budgeting to analyze the profitability of an investment. It is usually calculated using tables and spreadsheets such as Microsoft Excel, but the main formula used to calculate net present value...
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...Capital Budgeting Processes and Techniques Keith A. Rossmiller Business 657 Instructor Maxwell September 3, 2012 Capital Budgeting 2 Capital Budget Processes and Techniques Investment decisions impact the long-term success or failure of a company. The capital budgeting theory assumes that the primary goal of a firm’s shareholders is to maximize firm value. The process of analyzing and prioritizing investment opportunities is capital budgeting. Capital budgeting involves three basic steps of identifying potential investments, analyzing the set of investment opportunities that will create shareholder value, and implementing and monitoring the investment projects that a firm should undertake. Managers need analytical tools to help them make the best investment decisions for their firm. This paper will explore six different methods of evaluating investment projects and their advantages and disadvantages. The six methods are the payback period, discounted payback period, net present value, profitability index, internal rate of return, and modified internal rate of return, which method is most used in business, and issues related to capital budgeting. Capital Budgeting 3 Payback Period The first...
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...Bryan Kimmell How do CFOs make capital budgeting and capital structure decisions? Introduction A comprehensive survey is gone that describes the current practice of corporate finance. The survey will give us a betting understanding of where the theory and practice of corporate finance are consistent and areas where they are not. The survey conducted is based on two parts, capital budgeting and capital structure. The survey goes deeper and tries to find out what causes capital budgeting and structure decisions in firms. The survey consists of 100 questions to explore capital budgeting and structure decisions in depth. The original sample for the survey was 4,440 firms but only 392 CFOs responded to the survey, making the response rate a dramatic 9%. The results of the survey were analyzed based on firm characteristics. The responses given by the executives are compared in relation to the firm size, P/E ratio, leverage, credit rating, dividend policy, industry, management ownership, CEO age, CEO tenure, and CEO educational attainment. Comparing the responses to all these variables gives the results a more meaningful explanation because it is able to test various finance theories. The responses to the capital budgeting portion of the survey follow academic advice and use present value techniques to evaluate new projects. But when it comes to capital structure, firms rely on practical, informal rules and pay less attention to academic advice. Survey Methodology Before the...
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...2016 Background of the Case: Robert Montoya, Inc. (RMI), one of the biggest wine producers in the United States, is planning to expand on its product offerings. RMI is owned by Robert Montoya, his brother and a few partners which sells wine throughout the world. However, one of its products, wine coolers, has been recording a decline in sales. To address this, the management is looking into expanding its product offerings, to include Suave Mauve, a premium variety of wine which uses the cabernet sauvignon grape. The new product is targeted for the middle-to upper-income professionals. It would be positioned between the traditional table and wines and super premium table wines. The management has assigned Sarah Sharpe, RMI FVP for Finance, to assess the new venture along with two other possible investments. Below are the details of the planned project: ITEM | REMARKS | Production facility location | At the unused section of the main plant | New Machinery | $2,200,000 | Shipping Cost | $80,000 | Installation | $120,000 | Increase in inventory due to the new wine variant | $100,000 | Cash flow | Assumed to occur at the time of initial investment | Machine remaining economic life | 4 years | Salvage value after 4 years | $150,000 | Depreciation under MACRS 3 year class life | Depreciation allowance 0.33 (Yr.1), 0.45 (Yr.2), 0.15 (Yr.3), 0.07 (Yr.4) | Site rehabilitation (previous year) | $300,000 | Sales projection for 4 years | 100,000 bottles...
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...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 cost of capital is the weighted average of each capital source fund. The cost of capital is known as the, Weighted Average Cost of Capital (WACC). The WACC includes many factors as profitability, credit worthiness, debt history, and other finance factors. WACC gives a firm a benchmark to where it should receive any gain. Since firms...
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...Instructor Guide CORPORATE FINANCE COURSE NUMBER: MBA591 [pic] Jones International University®, Ltd. 1.800.811.JONES (5663) http://www.jonesinternational.edu ©2008 Jones International University®, Ltd. All rights reserved. 9697 East Mineral Avenue, Englewood, Colorado 80112, USA This workbook and all accompanying audio-visual material, manuals and software (collectively, the "Materials") are copyrighted with all rights reserved. Under the copyright laws, none of the Materials may be copied in whole or in part without prior written consent of Jones International University®, Ltd. (JIU™) You may permanently transfer all of your rights in the Materials, provided that you retain no copies, and provided that you transfer all of the Materials (including all component parts, media, documentation and any prior versions and upgrades). You may not copy or allow any copies of the Materials to be made for others, whether or not you charge anyone else for the copies. Limitation of Liability. JIU™ PROVIDES ALL OF THE MATERIALS “AS IS” WITHOUT WARRANTY OF ANY KIND. EACH OF JIU AND ALL ITS DEVELOPERS, TEACHING FACULTY, DIRECTORS, OFFICERS, EMPLOYEES OR AFFILIATES DISCLAIM ALL OTHER WARRANTIES, EITHER EXPRESS OR IMPLIED, INCLUDING BUT NOT LIMITED TO IMPLIED WARRANTIES OF MERCHANTABILITY, NONINFRINGEMENT AND FITNESS FOR A PARTICULAR PURPOSE. IN NO EVENT WILL JIU OR ITS DEVELOPERS, TEACHING...
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...acquiring a permanent assets is taken, it becomes very difficult to dispose of these assets with the incurring heavy cost • Long term effect on profitability- Not only the present earning of the firm is affected but the future growth and profitability also depend upon investment decision taken today, any unsound decision made can lead to a downfall tomorrow Capital budgeting is a complex process as it involved decision relating to the investment of current funds for the benefit to be achieved in the future but future is always uncertain. The 5 step process in capital budgeting decision is: I. Identified investment opportunities- investment proposal or projects normally was initiated by a firm’s management or staffs in line with the corporate objective e.g. maximise market shares, developing new markets, etc II. Analyse & consider alternative- management are required to screen & select alternatives to be taken out of numbers of projects proposed within the firm III. Analyse & project evaluation- projects pass through preliminary screening phase are subject to financial appraisal / project evaluation to ascertain if they are...
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...Part one: Multiple choices: 1. The approach focused mainly on the financial problems of corporate enterprise. a. Ignored non-corporate enterprise 2. These are those shares, which can be redeemed or repaid to the holders after a lapse of the stipulated period. c. Redeemable preference shares 3. This type of risk arises from changes in environmental regulations, zoning requirements, fees, licenses and most frequently taxes. b. Domestic risk 4. It is the cost of capital that is expected to raise funds to finance a capital budget or investment proposal. a. Future cost 5. This concept is helpful in formulating a sound & economical capital structure for a firm. c. Designing optimal corporate capital structure 6. It is the minimum required rate of return needed to justify the use of capital. b. Firms point 7. It arises when there is a conflict of interest among owners, debenture holders and the management. d. Agency costs 8. Some guidelines on shares & debentures issued by the government that are very important for the constitution of the capital structure are: a. Legal requirement 9. It is that portion of an investments total risk that results from change in the financial integrity of the investment. b. Default risk 10. _____________ measure the systematic risk of a security that cannot be avoided through diversification. a. Beta Part Two: 1. What do you understand by wealth maximization...
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...recommendation are. Incremental Cash Flow In regards to Capital budgeting, an incremental cash flow is used to help evaluate a project. It shows the firm's potential cash flows which can help make the decision of whether to accept or reject a project. Net Present value "An investment is desirable and should be accepted if the NPV is positive and of course rejected if it is negative"(Ross 2007) unless regulation forced it. If you have a negative NPV it is very unlikely you will be able to cover the costs of the initial outlay. Looking at the incremental cash flow, Vienna Orthopedics has a positive NPV of $ 308,001.32. This is very profitable and should definitely be taken to maximise the shareholder's wealth Internal Rate of Return IRR is another method used in measuring capital budgeting to figure out whether a project is desirable. It is an alternative to NPV, both of which are linked together. The market rate is 12% as opposed to the IRR which is a 109%, which is considerably higher. Based on the IRR rule you should accept a project if the IRR is higher than the required return & reject the project if it is lower than the rate. (Fundamentals of Corporate Finance) Payback Period The Payback period is the amount of time it takes to repay the initial investment. In this case we have a payback period 1 year. Simply put, you would have made enough revenue to repay the sum of your...
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...Handouts for Corporate Finance 1 Capital Budgeting Introduction A logical prerequisite to the analysis of investment opportunities is the creation of investment opportunities. Unlike the field of investments, where the analyst more or less takes the investment opportunity set as a given, the field of capital budgeting relies on the work of people in the areas of industrial engineering, research and development, and management information systems (among others) for the creation of investment opportunities. As such, it is important to suggest that students keep in mind the importance of creativity in this area, as well as the importance of analytical techniques. Because a project is financially sound, it must be ethically sound, right? Well . . . the question of ethical appropriateness is less frequently discussed in the context of capital budgeting than that of financial appropriateness. Consider the following simple example: The American Association of Colleges and Universities estimates that 10 percent of all college students cheat at some time during their postsecondary education careers. You might pose the ethical question of whether it would be proper for a publishing company to offer a new book How to Cheat: A User's Guide. The company has a cost of capital of 8% and estimates it could sell 10,000 volumes by the end of year one and 5,000 volumes in each of the following two years. The immediate printing costs for the 20,000 volumes would be $20,000. The...
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...[pic] SCHOOL OF BUSINESS, ECONOMICS AND MANAGEMENT AFIN 209 - CORPORATE FINANCE AND FINACIAL MODELLING MID TERM EXAMINATION SEPTEMBER 2012 Time allowed: 3 HOURS plus 5minutes reading time Instructions to Candidates: 1. Check that you have the correct examination in front of you. 2. There are SIX (6) questions in this paper. Answer FOUR (4) questions. 3. All questions must be answered on the answer sheet only. 4. Begin each question on a new page. 5. Discount tables have been provided 6. There shall be no any form of communication between students during the examination. Any students caught doing this will be disqualified. DO NOT TURN THIS PAGE UNTIL YOU ARE TOLD TO DO SO. QUESTION ONE a) Assume the total cost of a university education will be $185632.5 when your child enters college in 18 years. You presently have $15000 to invest. What annual rate of interest must you earn on your investment to cover the cost of your child’s university education? ( 6 Marks) FV = PV (FIVIF r,t) $185632.5 = $15000(FIVIF r,18) (FIVIF r, 18) = $185632.5/$15000 (FIVIF r, 18) = 12.3755 Therefore Check the value 12.3755 in the period of 18 years in the future value factor tables r= 15% b) A student requires K11, 000,000 to clear an outstanding balance before graduating in two (2) years time. How much should he invest now at 9% compounded quarterly...
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...first need to determine their working capital. “Working capital rises over the early years of the project as expansion occurs. However, all working capital is assumed to be recovered at the end, a common assumption in capital budgeting” (Ross, Westerfield, & Jaffey, 2005, p. 183). SAI is expecting growth will be 20% in the first three years and then decrease 10% annually in years 4 and 5. SAI is expecting increasing competition, decreasing prices, and a short lifespan of the technology that could be obsolete before the lifespan of the project itself. Although increasing the volume of units will increase the NVP and IRR, this is not a feasible solution, nor is it a sustainable one. Instead SAI should consider a modest, yearly increase and encourage a high percentage of sales as the most viable option. Throughout this process, the CFO made extensive use of IRR and NVP analysis to guide their decision...
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...Copyright : All rights reserved. No part of this course may be reproduced in any form by any means without prior permission in writing from: 0 BUSINESS FINANCE OUbs002223 January 2014 OUbs002223 Business Finance Table of Contents Unit 1 Agency Issue between shareholders and managers Unit 2 Investment appraisal methods Unit 3 Risks and Return Unit 4 Asset Pricing Models, CAPM & APT Unit 5 Capital Market Efficiency and Stock Market Anomalies Unit 6 Cost of Capital, Shareholder’s wealth, Gearing & Leasing Unit 7 The dividend decision Unit 8 Corporate Restructuring 1 Aim of the Module To provide learners with knowledge of the principles and practice of the financing decisions of enterprises. Learners will learn about the decisions which firms make about financing their investments in productive capital. Teaching and learning strategy The teaching and learning strategy is designed to develop in students an ability to understand the mechanisms of financial markets and the issues pertaining to investment decision in those markets. Students should be able to understand and apply the time value concepts with regards to investment decision. They should also be able to evaluate the risks and returns of financial instruments. Assessment Strategy Unit(s) of Assessment Assignment WrittenExamination Weighting Towards Module Mark (%) 30 70 GUIDELINES FOR SELFSTUDY ...
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