...CHAPTER 7 INTRODUCTION TO CAPITAL BUDGETING 7.1 7.2 7.3 7.4 7.5 7.6 7.7 7.8 7.9 7.10 7.11 Overview 159 The NPV Rule for Judging Investments and Projects 159 The IRR Rule for Judging Investments 161 NPV or IRR, Which to Use? 162 The “Yes–No” Criterion: When Do IRR and NPV Give the Same Answer? 163 Do NPV and IRR Produce the Same Project Rankings? 164 Capital Budgeting Principle: Ignore Sunk Costs and Consider Only Marginal Cash Flows 168 Capital Budgeting Principle: Don’t Forget the Effects of Taxes—Sally and Dave’s Condo Investment 169 Capital Budgeting and Salvage Values 176 Capital Budgeting Principle: Don’t Forget the Cost of Foregone Opportunities 180 In-House Copying or Outsourcing? A Mini-case Illustrating Foregone Opportunity Costs 181 Accelerated Depreciation 184 Conclusion 185 Exercises 186 158 0195301501_158-192_ch7.qxd 11/3/05 12:47 PM Page 159 CHAPTER 7 Introduction to Capital Budgeting 159 OVERVIEW Capital budgeting is finance terminology for the process of deciding whether or not to undertake an investment project. There are two standard concepts used in capital budgeting: net present value (NPV) and internal rate of return (IRR). Both of these concepts were introduced in Chapter 5; in this chapter we discuss their application to capital budgeting. Here are some of the topics covered: • Should you undertake a specific project? We call this the “yes–no” decision, and we show how both NPV and IRR answer this question. • Ranking projects: If you have...
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...Procedure Cash Management Cash Management 1. DEFINITIONS............................................................................................................. 3 1.1. Cash Management ............................................................................................................................... 3 1.2. Cash Flow Analysis ............................................................................................................................. 3 2. SCOPE ....................................................................................................................... 3 3. TARGET/PURPOSE .................................................................................................. 3 3.1. Cash Management on plant/location level ........................................................................................3 3.2. Cash Management on group level ..................................................................................................... 3 4. CASH MANAGEMENT PROCESS ............................................................................ 4 4.1. Golden rule for cash and finance management at CO. ................................................................... 4 4.2. Cash Management Instruments ......................................................................................................... 4 4.3. Payment terms .............................................
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...College of Business and Science BTEC Level 3 National Extended Diploma Fall 2017 Unit 5: Business Accounting Assignment 1: Cash flow P1, P2, P3, M1 & D1 Submitted by Zuwena Suleiman Seif ID number 20178122 Submitted to Mr. Bou 26th November 2017 INTRODUCTION In this assignment, I will be explaining and show you how will I able to create the Cash Flow Forecast for one year from January 2018 up to December 2018. Also, I’ll explain the importance of record and keeping accurate financial data and how this record will help me to run and setting up my business. Not only that, but also, I will determine the closing balance of my Cash Flow Forecast in 1year which will base on the data that I’m going to predict in it together with...
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...Contents 1:0 TO IDENTIFY THE RELEVANT CASH FLOWS TO EVALUATE THE PRODUCTION OF THE NEW SECURITY RIGHT 1 1.1 OPORTUMNITY COST 1 1.2 CASH FLOWS VS PROFIT 2 1.3 WORKING CAPITAL 2 1.3 OVERHEARDS 2 1.4 SUNK COST 2 2.0 A REPORT ON THE RECOMMENDATION IF THE PROJECT IS ACCEPTED OR REJECTED 3 3.0 TO CALCULATE THE NET PRESENT VALUE OF THE NEW PRODUCT USING GLOW PLC 3 4.0 TO CALCULATE THE INTERNAL RATE OF RETURN 4 5.0 TO WRITE A REPORT ON THE ADVISABILITY OF ACCEPTING THE CONTRACT AND ANY ADDITIONAL FACTORS TO BE CONSIDERED 5 1:0 TO IDENTIFY THE RELEVANT CASH FLOWS TO EVALUATE THE PRODUCTION OF THE NEW SECURITY RIGHT For the financial managers to evaluate investment opportunities, they must first determine the relevant cash flows which are the incremental investment and resulting subsequent inflows associated with the proposed capital expenditure. Incremental cash flows are the additional operating cash flow that an organization receives from taking on a new a project, and this incremental cash flow is divided into scenarios and namely; the positive incremental cash flow and the negative cash flow. The positive incremental cash flow means that the company’s cash flow will increase with the acceptance of the project and vice versa. The following are the relevant cash flows that have been identified in the production of the new security right in Glow Plc. of an Irish manufacturer. 1.1 OPORTUMNITY COST Opportunity cost refers to what you have to give up buying what...
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...Team B choose two health organizations to compute the quick and current liquidity ratios, the DuPont ratio, profit margin, asset utilization, and financial leverage. The health organizations chosen are Happy Hospital and Health Management Associates. Within these two organizations the learning team will be discussing how differences in the industries and different measurements conventions affect presentations, and if one of the companies uses the cash basis of accounting, how would that differ from the accrual basis. The team will also be discussing in what ways the elements of the financial statements interact with one another. How might changing one of the financial statements affect the other financial statements? Why is it essential to understand the relationship between the financial statements? In what ways do the elements of the financial statements interact with one another? The objectives of Financial Statement presentation are to show an interrelated financial depiction of an entity's activities, to disaggregate information so that it is useful in evaluating an entity's future cash flows, and to present information about liquidity and financial flexibility of said entity. An organized financial picture means items in financial statements are clear and that the financial statements of an entity complement one another regularly. Financial statement analysis aimed at objectives such as assessing the amount, timing, and uncertainty of future cash flows requires financial...
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... Capital Budgeting: Estimating Cash Flow ------------------------------------------------- and Analyzing Risk ANSWERS TO BEGINNING-OF-CHAPTER QUESTIONS 13-1 The firm’s FCFs reflect both its past and current investments. Past investments produce current FCFs, but current investments are expected to add to FCF at some future point. Conceptually, a project’s projected cash flows and are expected to contribute that same amount to the firm’s future free cash flows. In practice, project cash flows are analyzed to determine what projects the firm will invest in, and then the sum of those investments, and the cash flows they produce, will in the future be reflected in the firm’s FCFs. If a firm identifies and then invests in positive NPV projects, this will increase the value of its operations as determined by the FCF model. The central issue is analyzing individual projects, and here the key factor is assessing the cash flows. See the BOC spreadsheet model. We go through the model to show how capital budgeting projects are analyzed. In this case, the initial NPV, IRR, and MIRR, all evaluated at the 12% average cost of capital and using the expected input values, indicate that the firm should accept the project. However, the risk analysis as done in the scenario analysis indicates that the project is riskier than average, hence the evaluation should be done with a somewhat higher WACC. Note that firms have two types of assets—-assets-in-place...
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...INVESTMENT APPRAISAL HANDOUT Example The capital investment committee of a state owned corporation is currently considering two projects. The estimated income from operations and net cash flows expected from each operation are as follows: | PROJECT A | PROJECT B | Year | Income from operations$ | Net Cash Flow$ | Income fromOperations$ | Net Cash Flow$ | 1 | 12,000 | 44,000 | 26,000 | 58,000 | 2 | 18,000 | 50,000 | 20,000 | 52,000 | 3 | 20,000 | 52,000 | 16,000 | 48,000 | 4 | 16,000 | 48,000 | 16,000 | 48,000 | 5 | 22,000 | 54,000 | 6,000 | 38,000 | | 88,000 | 248,000 | 84,000 | 244,000 | Each project requires an investment of $160,000. Straight line depreciation will be used, and no residual value is expected. The committee has selected a rate of 15% for purposes of the net present value analysis Required 1. Calculate the following: a) The average rate of return for each project b) The net present value for each project. Use the present value of $1 table available on the internet http://highered.mcgraw-hill.com/sites/0072994029/student_view0/present_and_future_value_tables.html 2. Why is the present value of Project B greater than Project A even though its average rate of return is less? 3. Prepare a summary for the capita; investment committee, advising it on the relative merits of the two projects SOLUTION 1. a ) Average rate of return for Project A $88,000 /5 = 22% ($160,000 +$0) /2 b) ) Average...
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...Introduction While United States Generally Accepted Accounting Principles (U.S. GAAP) are required throughout the United States, other countries utilize other methods of classifying their financial statement items. While the standards of accounting differ among many countries, there has recently been an effort to attain a universal set of standards under International Financial Reporting Standards (IFRS). While this has not yet been achieved, multiple countries have made an effort to converge their standards with IFRS. This paper attempts to illustrate the diversity that currently exists throughout the accounting world, briefly comparing several key differences of U.S. GAAP to the standards used in Hong Kong, China, Mexico, and the United Kingdom. Hong Kong With a few minor exceptions, Hong Kong has officially converged its financial reporting standards with IFRS effective January 1, 2005 (AdoptIFRS.org). Hong Kong’s primary GAAP-required statements are known as Hong Kong Financial Reporting Standards (HKFRSs), including their interpretations (Deloitte Global Services Limited, 2013). Other mandated GAAP requirements are found in Hong Kong’s Companies Ordinance as well as its Listing Rules (Deloitte Global Services Limited, 2013). The following paragraphs briefly highlight key financial statement items and their differing treatments by Hong Kong under IFRS and U.S. GAAP. The Balance Sheet While U.S. GAAP only provides a small amount of direction when clarifying how assets...
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...benefits and costs of each alternative over a specified study period. The Minimum Attractive Rate of Return (MARR) The lowest interest rate acceptable to the investor. Comparing Mutually Exclusive Alternatives The most common evaluation techniques include 1. Present worth analysis, 2. Annual (periodic) worth analysis, 3. Future worth analysis, 4. Internal rate-of-return, 5. Benefit-cost ratio, and 6. Payback period method. Below is a discussion of each of these techniques. Present Worth (PW) Analysis Objective: To evaluate and compare mutually exclusive alternatives based on the equivalent netpresent worth of the lifecycle cash flows for each alternative at a given minimum attractive rate of return (MARR). • The net present worth is computed as Net PW = PW(Revenues) – PW(Costs) • The cash flows include all life-cycle revenues and costs, i.e., all revenues and costs over the service life of the project or investment. • A zero or positive “Net PW” indicates a “profitable” or “economical” project or investment. • A positive “Net PW” indicates that the investment or project has an annual rate of return greater than the MARR. • A zero “Net PW” indicates that the investment or project has an annual rate of return exactly equal to MARR. • Similarly, a negative “Net PW” indicates that the investment/project has an annual rate of return less than MARR, hence, not preferable. • When comparing alternatives, the alternative with a higher...
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...statement, statement of cash flows, and retained earnings statement. Each statement provides unique information used for financial decision making. Balance Sheet The balance sheet describes a business on a specific date and has three sections: assets, liabilities, and the owner’s equity. Assets are resources held by the company. Cash is the first asset listed. Assets quickly converted to cash are listed next and permanent assets, such as land are listed last. Liabilities are the company’s debts such as accounts payable and salaries payable. Liabilities are listed in the order that they are repaid. Owner’s equity is the owner’s claims on the assets of the business and has two sections: capital stock and retained earnings. The total assets must equal the sum of all the liabilities and owner’s equity. Income Statement The income statement is a lists a company’s revenues and expenses for a period of time. Revenue is an increase in the company’s assets through its profit-making activities that increase positive cash flow. Expenses are decreases in the company’s assets through its profit-making activities that result in negative cash flow. Net income results if total revenue minus total expenses is a positive number. If the difference is a negative number, it is a net loss. Statement of Cash Flows This statement list the company’s cash flow under three types of activities: operating, investing, and financing. Operating activities are the cash flow because of revenue...
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............................................................. x Conventions Used In This Book .......................................................................xi Craig’s Challenge ........................................................................................... xiii The Excel Modeling and Estimation Series .................................................. xiii Suggestions for Faculty Members ..................................................................xiv Acknowledgements ........................................................................................... xv About The Author ................................................................. xvi PART 1 TIME VALUE OF MONEY ..... 1 Chapter 1 Single Cash Flow ....................................................1 1.1 Present Value ............................................................................................... 1 1.2 Future Value ................................................................................................ 2 Problems .............................................................................................................. 3 Chapter 2 Annuity ...................................................................4 2.1 Present Value...
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...Quarterly (N= 4 x 2 = 8 % and I = 8 / 4 = 2% per quarterly annual period) 9-7 Consider another uneven cash flow stream: Year Cash Flow 0 $2,000 1 2,000 2 0 3 1,500 4 2,500 5 4,000 a. What is the present (Year 0) value of the cash flow stream if the opportunity cost rate is 10 percent? b. What is the future (Year 5) value of the cash flow stream id the cash flows are invested in an account that pays 10 percent annually? c. What cash flow today (Year 0), in lieu of the $2,000 cash flow, would be needed to accumulate $20,000 at the end of Year 5? (Assume that the cash flows for Years 1 through 5 remain the same) d. Time value analysis involves either discounting or compounding cash flows. Many healthcare financial management decisions---such as bond refunding, capital investment, and lease versus buy---involve discounting projected future cash flows. What factors must executives consider when choosing a discount rate to apply to forecasted cash flows? 9-11 Consider the following investment cash flows: Year Cash Flow 0 ($1000) 1 250 2 400 3 500 4 600 5 600 a. What is the return expected on this investment measured in dollar terms of the opportunity cost rate is 10 percent? b. Provide an explanation, in economic terms, of your answer. c. What is the return on this investment measured in percentage terms? d. Should this investment be made? Explain your answer? Chapter 10 10-1 Consider the following probability distribution of returns estimated for a...
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...It’s been two months since you took a position as an assistant financial analyst at Caledonia Products. Although your boss has been pleased with your work, he is still a bit hesitant about unleashing you without supervision. Your next assignment involves both the calculation of the cash flows associated with a new investment under consideration and the evaluation of several mutually exclusive projects. Given your lack of tenure at Caledonia, you have been asked not only to provide a recommendation, but also to respond to a number of questions aimed at judging your understanding of the capital budgeting process. The memorandum you received outlining your assignment follows: TO: The Assistant Financial Analyst FROM: Mr. V. Morrison, CEO, Caledonia Products RE: Cash Flow Analysis and Capital Rationing We are considering the introduction of a new product. Currently we are in the 34 percent marginal tax bracket with a 15 percent required rate of return or cost of capital. This project is expected to last five years and then, because this is somewhat of a fad project, to be terminated. The following information describes the new project: Cost of new plant and equipment: $7,900,000 Shipping and installation costs: $ 100,000 Unit sales: Year Units Sold 1 70,000 2 120,000 3 140,000 4 80,000 5 60,000 Sales price per unit: $300/unit in years 1–4, $260/unit in year 5 Variable cost per unit: $180/unit Annual fixed costs: $200,000 Working-capital requirements: There will...
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...Accrual Accounting Two methods used to help human service organizations keep financial records according to Martin (2001), are referred to as “cash accounting and accrual accounting” (pg. 8, Cash and Accrual Accounting). However the accrual method is highly preferred and for many organizations this method is required. This paper will discuss their differences, why accrual accounting is important, and the importance of a cash flow statement with regard to financial management of an organization. Although cash accounting and accrual accounting are methods used to keep financial records, each method focuses on a different recording and reporting time frame pertaining to revenues and expenses. With cash accounting there are no records of receivables, payables, and this method lacks the ability to track partial payments. This is because revenues are recorded as of the date they are received despite when they are earned, and expenses are recorded as of the date they are paid despite when they are incurred (Snyder, n.d.). With accrual accounting revenues are recorded when earned despite when they are received, and expenses are recorded as they are incurred rather than when they are paid (Snyder, n.d.). The accrual method is important because it better reflects the organizations outcomes regarding their operations. Unlike cash accounting, accrual accounting includes receivables and payables, and revenues and expenses are recorded in full despite the fact that partial payments may...
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...NPV We can compute a net present value for each project to decide which project creates more value. First, we need to figure out the initial cash outflow of each project. Table 1 and table 2 illustrate the initial cash outflows of MMDCL and DYOD separately. As the upfront R&D and marketing are tax deductible and the tax rate is 40%, the initial expenditures are $3.02 million and $5.331 millions. Next step is to calculate the unlevered cash flows of each year. As the result 9.2 (p.310) illustrates, unlevered cash flow = profit before interest and taxes + depreciation and amortization – change in working capital – capital expenditures + sales of capital assets – realized capital gains + realized capital losses – profit before interest and taxed * tax rate.The process of computing the working capital from year 2010 to 2020 was explained in Table 3 and Table 4. The computation of the unlevered cash flows for each project was illustrated in Table 5. As the case pointed out, project MMDCL entailed moderate risk, which is 8.4%, while project DYOD revealed a relatively high risk, which is 9%. In addition, both projects can create indefinitely value if it is given continuing investment. As a consequence, when calculate the net present value; we have to regard it as a growing perpetuity. The U.S. retail sales of dolls were planed to grow at a constant rate by 3% per year. To persuade a conservative projection, we used a relatively low perpetual growth rate, which is 2% in this case. Therefore...
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