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FNCE30002 Lecture Notes - Lecture 5: Inter-Active Terminology For Europe, Cash Flow, Net Present Value

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orchidgnu53
27 Jul 2018
School
University of Melbourne
Department
Finance
Course
FNCE30002
Professor
Pinder

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Document Summary

Capital budgeting i: comparing mutually exclusive projects with different lives (ccr: dealing with the investment decision, adapting standard npv approach to ensure we"re making optimal decision maximising shareholder value. N e t p r e s e n t v a l u e: c are the period cashflows per annum r is the required rate or return, or discount rate. I0 is the initial investment in the project n is the number of years (cid:2777)= (cid:2777)+[(cid:2778) from year 5 onwards, hence (cid:1840)(cid:1842)= (cid:4666)(cid:2869)+(cid:4667)5. C a p i t a l b u d g e t i n g: sv is the salvage valued received from selling (cid:2778)(cid:4666)(cid:2778)+(cid:4667)]+ (cid:1840)(cid:1842)= (cid:2869) (cid:4666)1+(cid:4667)(cid:2869)+ (cid:4666)(cid:2778)+(cid:4667) (cid:1867) (cid:1840)(cid:1842)(cid:2868)= (cid:2868)+[1 (cid:4666)1+(cid:4667)(cid:2870)+ (cid:2870) (cid:4666)1+(cid:4667) (cid:2868) Where cashflows are consistent across periods (annuity) the npv formula simplifies to: Note: if a cashflow isn"t in the current year, make sure to discount it (e. g. )

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Related Questions

Required:
Compare the results of the three (3) methods by quality of information for decision making. Using what you have learned about the three (3) methods, identify the best project by the criteria of long term increase in value. Convey your understanding of the Time Value of Money principles used or not used in the three (3) methods.

Scenario Information:
Assume that two gas stations are for sale with the following cash flows; CF1 is the Cash Flow in the first year, and CF2 is the Cash Flow in the second year. This is the time line and data used in calculating the Payback Period, Net Present Value, and Internal Rate of Return. The calculations are done for you. Your task is to select the best project and explain your decision. The methods are presented and the decision each indicates is given below.

Investment Sales Price CF1 CF2
Gas Station A $50,000 $0 $100,000
Gas Station B $50,000 $50,000 $25,000



Three (3) Capital Budgeting Methods are presented:

Payback Period: Gas Station A is paid back in 2 years; CF1 in year 1, and CF2 in year 2. Gas Station B is paid back in one (1) year. According to the payback period, when given the choice between two mutually exclusive projects, the investment paid back in the shortest time is selected.

Net Present Value: Consider the gas station example above under the NPV method, and a discount rate of 10%:
NPVgas station A = $100,000/(1+.10)2 - $50,000 = $32,644
NPVgas station B = $50,000/(1+.10) + $25,000/(1+.10)2 - $50,000 = $16,115

Internal Rate of Return: Assuming 10% is the cost of funds; the IRR for Station A is 41.421%.; for Station B, 36.602.

Summary of the Three (3) Methods:

Gas Station B should be selected, as the investment is returned in 1 period rather than 2 periods required for Gas Station A.

Under the NPV criteria, however, the decision favors gas station A, as it has the higher net present value. NPV is a measure of the value of the investment.

The IRR method favors Gas Station A. as it has a higher return, exceeding the cost of funds (10%) by the highest

Required:
Compare the results of the three (3) methods by quality of information for decision making. Using what you have learned about the three (3) methods, identify the best project by the criteria of long term increase in value. (You do not need to do further research.) Convey your understanding of the Time Value of Money principles used or not used in the three (3) methods. Review the video titled “NPV, IRR, MIRR for Mac and PC Excel” (located at https://www.youtube.com/watch?v=C7CryVgFbBc and previously listed in Week 4) to help you understand the foundational concepts:

Scenario Information:
Assume that two gas stations are for sale with the following cash flows; CF1 is the Cash Flow in the first year, and CF2 is the Cash Flow in the second year. This is the time line and data used in calculating the Payback Period, Net Present Value, and Internal Rate of Return. The calculations are done for you. Your task is to select the best project and explain your decision. The methods are presented and the decision each indicates is given below.

Investment Sales Price CF1 CF2
Gas Station A $50,000 $0 $100,000
Gas Station B $50,000 $50,000 $25,000



Three (3) Capital Budgeting Methods are presented:

Payback Period: Gas Station A is paid back in 2 years; CF1 in year 1, and CF2 in year 2. Gas Station B is paid back in one (1) year. According to the payback period, when given the choice between two mutually exclusive projects, the investment paid back in the shortest time is selected.

Net Present Value: Consider the gas station example above under the NPV method, and a discount rate of 10%:
NPVgas station A = $100,000/(1+.10)2 - $50,000 = $32,644
NPVgas station B = $50,000/(1+.10) + $25,000/(1+.10)2 - $50,000 = $16,115

Internal Rate of Return: Assuming 10% is the cost of funds; the IRR for Station A is 41.421%.; for Station B, 36.602.

Summary of the Three (3) Methods:

Gas Station B should be selected, as the investment is returned in 1 period rather than 2 periods required for Gas Station A.

Under the NPV criteria, however, the decision favors gas station A, as it has the higher net present value. NPV is a measure of the value of the investment.

The IRR method favors Gas Station A. as it has a higher return, exceeding the cost of funds (10%) by the highest return.

Compare the results of the three (3) methods by quality of information for decision making. Using what you have learned about the three (3) methods, identify the best project by the criteria of long term increase in value. (You do not need to do further research.) Convey your understanding of the Time Value of Money principles used or not used in the three (3) methods. Review the video titled “NPV, IRR, MIRR for Mac and PC Excel” (located at https://www.youtube.com/watch?v=C7CryVgFbBc and previously listed in Week 4) to help you understand the foundational concepts: Scenario Information: Assume that two gas stations are for sale with the following cash flows; CF1 is the Cash Flow in the first year, and CF2 is the Cash Flow in the second year. This is the time line and data used in calculating the Payback Period, Net Present Value, and Internal Rate of Return. The calculations are done for you. Your task is to select the best project and explain your decision. The methods are presented and the decision each indicates is given below. Investment Sales Price CF1 CF2 Gas Station A $50,000 $0 $100,000 Gas Station B $50,000 $50,000 $25,000 Three (3) Capital Budgeting Methods are presented: Payback Period: Gas Station A is paid back in 2 years; CF1 in year 1, and CF2 in year 2. Gas Station B is paid back in one (1) year. According to the payback period, when given the choice between two mutually exclusive projects, the investment paid back in the shortest time is selected. Net Present Value: Consider the gas station example above under the NPV method, and a discount rate of 10%: NPVgas station A = $100,000/(1+.10)2 - $50,000 = $32,644 NPVgas station B = $50,000/(1+.10) + $25,000/(1+.10)2 - $50,000 = $16,115 Internal Rate of Return: Assuming 10% is the cost of funds; the IRR for Station A is 41.421%.; for Station B, 36.602. Summary of the Three (3) Methods: Gas Station B should be selected, as the investment is returned in 1 period rather than 2 periods required for Gas Station A. Under the NPV criteria, however, the decision favors gas station A, as it has the higher net present value. NPV is a measure of the value of the investment. The IRR method favors Gas Station A. as it has a higher return, exceeding the cost of funds (10%) by the highest return.