Class Notes (837,446)
Canada (510,273)
York University (35,409)
ADMS 1500 (94)
Paul Evans (10)
Lecture

ADMS 1500 - Class 10 - Chapter 14.docx

6 Pages
85 Views
Unlock Document

Department
Administrative Studies
Course
ADMS 1500
Professor
Paul Evans
Semester
Winter

Description
Chapter 14 Strategy  Strategic Planning  Budgeting - Capital projects evaluation - Time value of money Capital A business may be thought of as two separate, but related, decision activities: • Raising Capital, and • Investing Capital The first decision activity is critical to the business success and relates to deciding how much capital to raise and from where. As seen last class, there are several sources of capital, each one with its own level of risk and cost. Investing capital in short term assets was seen previously under ‘working capital’ management (inventory, accounts receivable, accounts payable, cash, etc). Investing capital in long term assets will be seen in this class when discussing capital budgeting techniques. Decisions: Long and Short term Short-term decisions affect the organization for a short period, involve small amounts of money and can be reversed at little cost. Therefore a short-term decision that was unwise is a temporary and inexpensive problem. Long-term decisions affect the organization over a long period, involve a large amount of money and cannot be reversed, except at great cost. Therefore it is vitally important that long-term decisions be taken correctly. Capital Budgeting Decision Process 1: The process should be standardized throughout the organization. 2: The proposal should be a good fit with the organization’s strategy. 3: Economic analysis of the proposal should be based on forecasts of the following information: i: additional cash inflows from revenues; ii: additional cash outflows from expenses; iii: additional non-cash expenses; iv: weighted average cost of capital; v: risk assessment. 4: Forecast information should be analyzed through: i: payback; ii: return on investment; iii: net present value iv: risk analysis A Capital Budgeting Proposal Purchase of patent Cost $300,000 Increased sales revenue: $500,000 per year for 6 years Increased cash expenses: $425,000 per year for 6 years Depreciation ($300,000/6): $ 50,000 per year for 6 years Ignore increases in working capital (such as inventory and receivables changes) resulting from the investment. Question: Is this proposal economically justified? Payback method: Initial investment: $300,000 (one time only) Increased sales revenue: $500,000 per year for 6 years Increased cash expenses: $425,000 per year for 6 years Increased cash flow: $ 75,000 per year for 6 years Year 0: Cash outflow for Investment $300,000 Year 1: Cash inflow $ 75,000 End of year 1: unrecovered investment $225,000 Year 2: Cash inflow $ 75,000 End of year 2: unrecovered investment $150,000 Year 3: Cash inflow $ 75,000 End of year 3: unrecovered investment $ 75,000 Year 4: Cash inflow $ 75,000 End of year 4: unrecovered investment $ nil By the end of year 4 the investment should be “paid Payback—Deficiencies 1: Payback fails to consider all the cash flows: If you have three proposals that have a 4 year payback are you indifferent between receiving: Nothing beyond year 4, or – inferior because you’d be breaking even $75,000 in year 5 and 6, or $75,000 per year from year 6 forever. – you’d prefer this one(deficiency of the payback method) Clearly not! 2: Payback fails to consider the pattern of cash flows within the payback period: Would you be indifferent between: Year 1: $99,000; Year 2; $ 1,000, and (less risk of not getting your money back) – prefer this one Year 1: $ 1,000; Year 2; $99,000 Capital Budgeting and Cost Analysis - Decisions of large investments of money - Uncertain actual outcomes - Long lasting effects Capital Budgeting: process for making long term planning decisions for investments Central Concept: Time Value of Money Meaning that a dollar received today is worth more than a dollar received tomorrow – does not give you the means of the value that is concerned Example Problem For each of the following alternatives, state which is preferable: (a) $100 per month at the end of every month for a year, or $1,200 now The cash value is the same, only the timing differs. As it is better to get the money sooner than later, the $1,200 now is preferable. (b) $100 per month at the end of every month for a year, or $1,200 at the end of the year The cash value is the same, only the timing differs. As it is better to get the money sooner than later, the $100 per month is preferable. (c) $1,000 now or $1,150 at the end of one year This depends on the interest rate: If the interest rate is more than 15%, then the $1,000 now is better as interest will build it up to more than $1,150. If the interest rate is less than 15%, then $1,150 at the end of the year is preferable. If the interest rate is exactly 15%, then both are worth an equal. Discounted Cash Flow Methods - Discounted cash flow (DCF) measures cash inflows and outflows of a project as if they occurred at a single point in time - Focuses on cash inflows and outflows rather than net income - One common method is the net present value (NPV) Net present value (NPV) •Discount all expected future cash flows to the present using a minimum desired rate of return •Accept project if NPV > 0 Relevant Cash Flows in DCF Analysis 1. Initial investment in capital assets and working capital 2. Current disposal price of existing capital assets 3. Recurring operating cash flows 4. Terminal disposal price of investment in capital assets and recovery of working capital Initial investment in machinery & working capital. Current disposal values -----------------------------Terminal disposal values and recovery of working capital Recurring Operating Cash Flo
More Less

Related notes for ADMS 1500

Log In


OR

Join OneClass

Access over 10 million pages of study
documents for 1.3 million courses.

Sign up

Join to view


OR

By registering, I agree to the Terms and Privacy Policies
Already have an account?
Just a few more details

So we can recommend you notes for your school.

Reset Password

Please enter below the email address you registered with and we will send you a link to reset your password.

Add your courses

Get notes from the top students in your class.


Submit