FIN 300 Lecture Notes - Lecture 8: Managerial Finance, Net Present Value, Cash Flow

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emeraldhedgehog234

5 Dec 2016

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Determines whether to launch a new product or enter a new market. Capital budgeting decisions can determine the success of the business for many years. Is npv > 0 (accept deal, npv rule) Npv = -costs + pv cash in flows. This discount rate is known as the opportunity cost of capital. It is called this because it is the return you give up by investing in the project. Casio calculator: tvm cash flow npv. The difference between the market value of a project and its cost. The first step is to estimate the expected future cash flows (chapter 10) The second step is to estimate the required return for the projects of this risk level (chapter 13) The third step is to find the present value of the cash flows and subtract the initial investment (chapter 9) If the npv is positive, accept the project.

Related Questions

Capital budgeting involves choosing projects that add value to the firm. The net present value (NPV), internal rate of return (IRR) and payback period methods are the most common approaches to project selection. At its core, capital budgeting is measuring an accounting of costs versus benefits. In a way, all business decisions are a series of capital budgeting decisions. Get it wrong, and you can destroy a company.

The capital budgeting tools help financial managers decide on the desirability of the projects. In the real world, however, managers sometimes will make decisions that don't necessarily agree with the decision rules of the payback period, NPV or IRR methods.

For example, consider the two mutually exclusive projects below.

Investments	Cost	Cash Flow 1	Cash Flow 2
Project A	$ 50	$ -	$ 100
Project B	$ 50	$ 50	$ 25

According to the payback period, project B should be selected. Although both projects cost the same, project B has a payback period of one period, while project A will payback in roughly 1.5 periods.

Assuming the discount rate of 5%, NPV(A) = $41 and NPV(B) = $20.

This example illustrates the limitations of the payback period method. Even though the payback period method points to project B, the NPV method points to project A since it has more than twice the NPV value to that of project B. Yet the manager may choose project A. Why?

It may be that the project stakeholder is requesting a quicker return in cash.

For this discussion, create an example problem where two (or more) methods contradict each other. What would be the "appropriate" choice (which project would you choose)? In what cases would you not choose the "best" choice?

bluelizard621

Q6) Assume yourself as a financial analyst for the Great Land Company. Then, the director of capital budgeting asks you to analyse two proposed capital investments named Project A and Project B. Each project has a cost of 900,000 birr, and the cost of capital (the required rate of return) for each project is 10%. The information on the projects’ expected net cash flows are as follows with the present value of 1 birr at 10%.

Year	Cash flow of the projects in Birr		PV of 1birr at 10%
Year	Project A	Project B	PV of 1birr at 10%
0	- 900,000	- 900,000	1
1	400,000	245,000	0.909
2	350,000	245,000	0.826
3	250,000	245,000	0.751
4	150,000	245,000	0.683
5	100,000	245,000	0.621

Required:

Calculate each project’s payback period (PBP) and determine which project is preferable as per PBP results. (2 pts)
Calculate each project’s net present value (NPV). (2 Pts)
Determine and justify which project or projects should be accepted as per NPV results if they are independent projects. (2Pts).
Determine and justify which project or projects should be accepted as per NPV if they are mutually exclusive projects. (2Pts).
Calculate the internal rate of return (IRR) for each project and determine whether the projects are accepted or rejected as per IRR result and also determine which project is preferable based on IRR. (2Pts)
Discuss the relative strengths and limitations of the capital budgeting decision criteria that you have used above (Payback period, NPV and IRR).( 3Pts)

goldcoyote821

General Co. is considering investing $3,000,000 in a project that is expected to generate the following net cash flows:

Year 1 = $275,000

Year 2 = 400,000

Year 3 = 475,000

Year 4 = 475,000

General Co. uses WACC of 10% when evaluating proposed capital budgeting projects. Based on these cash flows, what is the project's profitability index (PI)?

General Co. decision to accept or reject the project is indepedent of its decision on other projects. Based on the project's PI, should the firm accept or reject?

By comparison, what is the NPV of this project? On the basis of evaluation criterion, should General Co. invest/not invest because the project will/will not increase the firm's value?

A project with a negative NPV will have PI that is equal to 1/greater than 1/less than 1 ; when it has a PI of 1.0, it will have a NPV greater than $0/less than $0/equal to $0 ?

Thank you!

ochregnat997

FIN 300 Lecture Notes - Lecture 8: Managerial Finance, Net Present Value, Cash Flow

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