Loading in 5 sec....

Capital Budgeting and Investment AnalysisPowerPoint Presentation

Capital Budgeting and Investment Analysis

- 200 Views
- Uploaded on

Download Presentation
## PowerPoint Slideshow about ' Capital Budgeting and Investment Analysis' - aiko-blevins

**An Image/Link below is provided (as is) to download presentation**

Download Policy: Content on the Website is provided to you AS IS for your information and personal use and may not be sold / licensed / shared on other websites without getting consent from its author.While downloading, if for some reason you are not able to download a presentation, the publisher may have deleted the file from their server.

- - - - - - - - - - - - - - - - - - - - - - - - - - E N D - - - - - - - - - - - - - - - - - - - - - - - - - -

Presentation Transcript

Introduction of Myself

- Research Areas:
- Agricultural Finance
- Agribusiness and Marketing
- Monetary and Macroeconomics
- Applied Econometric Analysis

- Teaching Experiences:
- Financial Management
- Econometric Analysis for Agribusiness Management
- Agribusiness Marketing

1

Topic Today

- Capital budgeting
- NPV approach.
- Examples.
- Amortization.

Review

- Definition of capital budgeting: analyzing the net after tax cash flows (inflows + outflows) associate with an investment accounting for the time value of money.
- Why Capital Budgeting is Important?
- Capital budgeting is the most significant financial activity of the firm.
- Capital budgeting determines the core activities of the firm over a long term future.
- Capital budgeting decisions must be made carefully and rationally.

3

Review

- Method
- Net Present Value (NPV)
- Internal Rate of Return (IRR) – Yield

- Decision Criterion and Rules
- Investment acceptable if NPV > 0
- Investment earnings greater than required rate of return

Review – Net Present Value Method

- Net after tax cash flows (NATCF)
- Additional cash inflows due to the investment less any additional cash outflows,
together with their timing (NBTCF).

b. NBTCF – Depreciation = taxable cash flows (TCF)

c. TCF * tax rate (t) = tax

d. NBTCF – tax = NATCF

- Additional cash inflows due to the investment less any additional cash outflows,
- Economic life = planning horizon
- Original cash outlay
4. Net after tax terminal value (NATTV)

- Market value – book value = gain
- Gain * tax rate = tax
- Market value – tax = NATTV
5. Discount rate = required rate of return

Example 2 – Question

- Purchase a combine to use for custom harvesting, cost $150,000
a. Put 30% down, finance the balance on a 3-year note requiring equal principal payments plus interest, using 9% interest on the remaining balance.

b. Assume a 5 year economic life (n=5)

c. Depreciate over 5 years, using straight line depreciation and assuming a $30,000 salvage value.

d. Actual terminal sales value is $50,000

6

Example 2 – Question

e. Net before tax cash flows from custom work

year 1 50,000

year 2 56,000

year 3 60,000

year 4 54,000

year 5 50,000

f. Tax rate t=25%

g. Required rate of return 15%

7

Example 2 - Solution

Loan payments

down payment 150,000*.3=45,000

loan 150,000-45,000=105,000

annual principal payments 105,000 / 3=35,000

At the time of sale: Book value =30,000

9

Example 2 - Solution

Layout cash flows

Year 1: TCF = NBTCF-Depreciation-Interest

= 50,000 - 24,000 - 9,450 = 16,550

tax = 16,550*0.25=4,138

NATCF1 = NBTCF – PRINCIPAL – INTEREST - TAX

= 50,000 – 35,000 – 9,450 – 4,134 = 1,412

Year 2:TCF= 56,000 – 24,000 – 6,300 = 25,700

tax = 25,700*.25 = 6,425

NATCF2 = 56,000 – 35,000 – 6,300 – 6,425 = 8,725

10

Example 2 - Solution

Year 3: TCF = 60,000 – 24,000 – 3,150 = 32,850

tax = 32,850*.25=8,213

NATCF3 = 60,000 – 35,000 – 3,150 – 8,213 = 13,637

Year 4: TCF = 54,000 – 24,000 = 30,000

tax = 30,000*.25 = 7,500

NATCF4 = 54,000 – 7,500 = 46,500

Year 5: TCF = 50,000 – 24,000 = 26,000

tax = 26,000*.25 = 6,500

NATCF5 = 50,000 – 6,500 = 43,500

11

Example 2 - Solution

Also:

gain = sale value – book value = 50,000 – 30,000 = 20,000

tax = 20,000*.25 = 5,000

NATTV5 = 50,000 – 5,000 = 45,000

Calculate NPV:

12

Example 3 - Question

Purchases a small office building for 500,000

- 20% down, finance balance on a 15 year note requiring equally annual payments including principal and interest. Using 8% interest on the remaining balance.
- Assume a 20 year economic life (n=20).
- Depreciate over 15 years using straight line depreciation and assuming a zero salvage value.
- Actual terminal sales value will be based on the original value of the property increasing at a rate of 5 percent per year.
- Net before tax cash flows from renting the building out:
- Year 1 75,000 Year 3 82,688
Year 2 78,750 Year 4 86,822

- Tax rate 28%, and capital gain tax rate 20%.
- Required rate of return 15%
You need calculate the NATCF for years 1-3 and the NATTV at the end of year 20.

13

Example 3 - Solution

- Annual depreciation = 500,000/15=33,333
- Loan payments
- Down payment 500,000*.2=100,000
- Loan 500,000 – 100,000 = 400,000
- Annual Payment (Principal + interest)
= 400,000 / USPV8%,15

= 400,000/8.5595 = 46,732

14

Example 3 - Solution

- Year 1: TCF = 75,000 – 33,333 – 32,000 = 9,667
tax = 9,667*.28 = 2,707

NATCF = 75,000 – 14,732 – 32,000 – 2,707= 25,561

- Year 2: TCF = 78,750 – 33,333 – 30,821 = 9,667
tax = 14,596*.28 = 4,087

NATCF = 78,750 – 30,821 – 15,911 – 4,087= 27,931

- Year 3: TCF = 82,688 – 33,333 – 29,549 = 19,806
tax = 19,806*.28 = 5,546

NATCF = 82,688 – 29,549 – 17,183 – 5,546= 33,002

……..

16

Example 3 - Solution

Now we calculate NATTV in the end of year 20.

- Sales price = 500,000*SPFV5%,20 = 500,000*2.6533
= 1,326,650

- Book value = 0
- Gain = 1,326,650 – 0 = 1,326,650
- Tax = 1,326,650*0.2 = 265,330
- NATTV20= 1,326,650 - 265,330 = 1,061,320

17

Amortization

- Definition: The gradual elimination of a debt in regular payments over a specified period of time. Such payments must be sufficient to cover both principal and interest.
- Steps to amortize a loan:
1. Calculate the payment per period.

2. Determine the interest in Period t

(beginning balance * interest rate)

3. Computeprincipal paymentin Period t.

(Payment - interest from Step 2)

4. Determine ending balance in Period t.

(Beginning Balance – Principal from Step 3)

5. Start again at Step 2 and repeat.

18

Usefulness of Amortization

- Determine Interest Expense - Interest
expenses may reduce taxable income of the firm.

- Calculate Debt Outstanding - The quantity of outstanding debt may be used in financing the day-to-day activities of the firm.

19

Any More Questions?

- Please fill the evaluation form and leave on the table.
- Thanks for your attendance!

20

Download Presentation

Connecting to Server..