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Recreation and Leisure Studies
Erin Sharpe

Capital Budgeting  Time value of money: the idea that money available at the present time is wroth more than the same amount in the future due to its potential earning capacity. Time allows you the opportunity to post pone consumption and ear interest.  Interest: the price paid for borrowing money, it is expressed as a percentage rate over a period of time and reflects the rate of exchange of present consumption for future consumption. o Simple interest= interest paid (earned) on only the original amount, or principle, borrowed (lent) o *Compound interest = interest paid (earned) on any previous interest earned, as well as on the principle borrowed (lent) o Simple interest formula: SI =Po (i) (n)  Si= simple interest  P = principle (deposit today (t=0)  I= interest rate per period  N= number of time periods o Compound interest formula: F=PTA o F= future value o T = Table A (page 64) o A= Table A (page 64) Example: 5000 investment for 5 years at 8% F1 = P (TA) = 5000 (1.469) = 7,349 F2 = p (TA) = 5000 (1.360) = 6,800 F3 = p (TA) = 5000 (1.260) = 6300 F4 = p (TA) = 5000 (1.166) = 5830 F5 = p (TA) = 5000 (1.080) = 5400 Total value after 5 years = 31, 679 versus 25000  Inflation: assuming a rate of inflation of 2.7% in which year would an operating budget of 30 million have more purchasing power? 1995, 1999, 2004? -> would go further in 1995. o Economic principle of inflation: in a free market economy, there is an increase in price of goods and services over time. (choc bar used to be 77 cents, how 1.50 now) o This leads to a reduction in the purchasing power of money  Future value: is the potential for an investment to grow over a period of time o Interest allows the growth of an investment o Inflation erodes the growth of an investment o (all effect the value of money)  Present value: is reflection of the beginning rate of principle, a term of investment, and the applicable interest rate. o P = F (TB)  P= present value  F = dollar amount  TB = table B o Example: assume you need 40, 000 in four years and anticipate an interest rate of 8%. o P = 40,000 (.735) (table b page 66, four years @ 8%) o P = 29,400  Net present value: used most often. o In the decision making process for a capital project, the investor wants to know if additional value is created by undertaking the project. o Is the difference between the present value of returns and the initial investment.(returns is what comes back to you as revenue) o Net present value takes into consideration the future value of money o Example:  You are ready to expand your operations. Your camp kitchen is small. If you were to renovate your kitchen you would be able to accommodate 30 more campers a week. This would bring you an estimated additional 15000 of revenue each year (assume annual returns each year). You have obtained as estimate for the cost of renovation. The estimated costs total to 50 000 and the renovation is estimated to last 10 years (in another 10 years it will require more renovations) what is the payback period of this investment?  Payback period: capital costs/ annual revenue  50 000 / 15 000 = 3.33  3 years 4 months  What is the net present value of the 50 000 renovation option? Is the investment better than the next best alternative, which is investing the equivalent capital in the market at a 9% interest rate? Would you move forward with the renovation?  NPV (calculating against a market value, am I going to come out ahead if I put my money towards the reno, or should I invest in the market?)  NPV = RTc – C  R = returns  C = capital outlay (50 000)  TC = table value  N = number of years (10 years)  I = interest rate (6.418) o = 15000 (6.418) – 50 000 o 46 270 reno (make more money doing reno, then putting it in market, just has to be higher than 0)  Unequal net present value o Means you are getting unequal returns, so a different way of calculating must be used. Must calculate each year separately. o Example: imagine the scenario: 100 000 invested results in 30 000 in year 1, 29 000 is year 2, 26 000 in year 3, 25 000 in year 4 and 18 000 in year 5. Year Yearly cash flow TB (8% interest) PV 0 100 000 1 30 000 .926 27780 2 29 000 .857 24853 3 26 000 .794 20644 4 25 000 .735 18375 5 18 000 .681 12258 =103 910 NPV = 3910 because 103 910 (total) – 1000 000 (invested) =  Interest rate o Initial investment / annual returns = Table C o Example  1 600 000/200 000 = 8  then got o table look at the number of years given (10) go across to the closest number to 8  Pay back period o The length of time it takes to repay the cost of initial investment o Pay back period = capital cost/ annual revenue.  Example: a new indoor tennis complex costs $1.6 million to build. It generates revenue of 200 000 per year (after paying operating expenses)  What is the pay back period?  1.6 million / 200 000  8 years  example: camp happy invests 30 000 to replace its canoes and this investment returns 9000 annually for the five years Pay back period Year flow Yearly cash flow Cumulative net cash 0 -30 000 -30 000 1 9000 21000 2 9000 12000 3 9000 3000 4 9000 6000 5 9000 15000 *Therefore 3 years = 27000 then 3000/9000 X 12 = 4. Pay back period = 3 years and 4 months o Using payback period as the appraisal tool, which project is the better investment: Project 1 Year Yearly cash flow Cumulative net cash flow 0 -250 000 -250 000 1 100 000 -150 000 2 100 000 -50 000 3 100 000 50 000 4 50 000 100 000 5 20 000 120 000 Project 2 Year Yearly cash flow Cumulative net cash flow 0 -250 000 -250 000 1 50 000 -200 000 2 50 000 -150 000 3 100 000 -50 000 4 120 000 70 000 5 120 000 190 000  Internal rate of return (IRR): o Another way of describing the investment opportunity cost of a project o Because the initial rate of return is a rate of quantity, it is an indicator of the efficiency, quality, or yield of an investment. o Used so much because you can compare different investment opportunities  Depreciation o The loss of or reduced productivity of these resources is recognized and quantified as depreciation. (decreasing in value)  Book value – original value and depreciates with time  amortization – to pay money that is owed for something  cash flow – movement of money in an organization  turnkey costs + operating costs (indirect and direct costs, so variable and fixed) (operating costs= unit cost)  Pay as you go approach- all money is needed before project begins  Pay as you use approach- fees help pay for the project  Debenture o Serial debenture:  most common  municipality pays a fixed annual amount until the loan (principles and interest) is paid in full o sinking fund debenture:  similar to serial except that no payment is made until the final year of the schedule, when the full amount is due  however the municipality usually puts money aside on an annual basis (first 2 3 , 4 don’t pay nothing, then they pay in 10 year all of it, plus interest) o balloon issue debenture:  municipality pays a fixed annual amount for several years, normally midway through, and then makes a payment that is much larger than previous payment. All remaining payments revert back to the original amounts until the end of the schedule. (pay annual payments, same amount all the time. Then they just pay a bunch (ex won lottery, so they pay a bunch)  capital reserve fund o funds that are set aside for use with specific projects that present a long term capital investment or that may be related to some sort of capital expense in the future. o Most municipalities earmark a small proportion of the tax levy 2-3% for the capital reserve funds. o Aligns with pay as you go approach listed above. Pricing Concepts Principles for developing a pricing strategy (article mccarville) o Importance of fairness (what is right or appropriate) o Desire for choice (variety and what is important to consumer) o Search for balance (has to be sustainable) o Need for communication (consumers have to be informed and has to be ongoing)  Price – the value that consumers give up, or exchange, to obtain a designed product  Opportunity cost – the benefits and opportunity you give up or miss out on by engaging in one activity over another  Psychological price – the stress, anxiety, or mental difficulty of buying a good or service. Stress of driving, parking, operating equipment, preparation.  Effort price – the effect required to participate. Convenience stores charge more because they reduce effort costs  Switching cost- the costs involved in moving from one brand to another  Reference price – the amount that the consumer feels that the service might or should cost and is derived from the consumers experience with similar activity. “cheap”, “reasonable”, “expensive”  Objective price- actual price charged for the service  Subjective price – how the consumer feels about the objective price, based on his or her reference (a word or expression, not a number)  Price sensitivity – o the number of available substitutes, o whether the item is a necessity, o purchase price in relation to customers resources, o switching costs, o whether price is used to infer quality.  Willingness to pay – when cost recovery goals are easily met because the calculated unit price is below an amount that all or most consumers are accustomed to paying or willing to pay, it may be appropriate (and perhaps necessary) to price the sport, at a “going rate”. Pricing methods  Arbitrary
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