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Business Finance. BA303 Michael Dimond. If you require a 12% annual return, what would you pay for… …$90 to be delivered in 1 year? ($80.3571) …$95 to be delivered in 2 years? ($75.7334) …$99 to be delivered in 3 years? ($70.4662) …all of the above?

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Business finance

Business Finance

BA303Michael Dimond


Discounting unequal cash flows

If you require a 12% annual return, what would you pay for…

…$90 to be delivered in 1 year? ($80.3571)

…$95 to be delivered in 2 years? ($75.7334)

…$99 to be delivered in 3 years? ($70.4662)

…all of the above?

By adding together the present values, you find the value of allthe cash flows in the stream.

Discounting unequal cash flows

i = 12%

?

99

90

95

0

1

2

3

90 ÷ (1+0.12)1

80.3571

75.7334

+ 70.4662

226.5567

There’s an easier way… kind of.

95 ÷ (1+0.12)2

99 ÷ (1+0.12)3


Using the calculator npv function
Using the calculator (NPV function) for…

  • NPV(12,0,{100,200,300,400,500})


Using the calculator npv function1
Using the calculator (NPV function) for…

  • NPV(9,0,{100,90,80,25},{1,1,1,6})



Project valuation decision making
Project Valuation & Decision Making for…

  • How do you properly answer the fundamental question?

  • Applications

    • Operating expenditures

    • Capital budgeting

    • Marketing campaigns

  • Considerations

    • Mutually exclusive projects (vs independent projects)

    • Capital rationing (vs unlimited funds)

    • Timing

    • Approval process

    • Ranking projects

  • Criteria

    • Key Criteria: NPV, IRR, PBP

    • Other criteria (PI, MIRR, etc.)


Pay back period pbp
Pay Back Period (PBP) for…

  • How long will it take to recoup the cash outlay?

    • For example, a machine which costs $1,000k and saves $250k per year would pay for itself in 4 years (1,000 ÷ 250).

    • Therefore, the payback period would be 4 years.

    • What would the PBP be for this project?

  • What labels might be put on the cost?

    • Initial Investment, I0, CF0

  • Why is PBP a valid criterion?

  • What are the weaknesses of judging projects on PBP?

0

1

2

3

4

100

100

100

100

Cost: $380


Internal rate of return irr
Internal Rate of Return (IRR) for…

  • IRR = the “interest” implied by a stream of cash flows

    • If IRR > hurdle rate, project should be approved

    • If IRR < hurdle rate, project should be rejected

  • Why is IRR a valid criterion?

  • What are the weaknesses of judging projects on IRR?


Using the calculator irr function
Using the calculator (IRR function) for…

  • IRR(-1100,{100,200,300,400,500})


Using the calculator irr function1
Using the calculator (IRR function) for…

  • IRR(-250,{10090,80,25},{1,1,1,6})


Net present value npv
Net Present Value (NPV) for…

  • Present value of a stream of cash flows, minus the cost

    • If NPV > 0, project should be approved

    • If NPV < 0, project should be rejected

    • What does NPV = 0 imply about the IRR for a project?

  • Why is NPV a valid criterion?

  • What are the weaknesses of judging projects on NPV?


Using the calculator npv function2
Using the calculator (NPV function) for…

  • Once you know the present value, how would you find NPV?

  • To find NPV easily, put the cost where CF0 goes in your calculator.

    • What if the initial investment were $1,100?


Using the calculator npv function3
Using the calculator (NPV function) for…

  • Once you know the present value, how would you find NPV?

  • To find NPV easily, put the cost where CF0 goes in your calculator.

    • What if the initial investment were $250k?


Profitability index pi
Profitability Index (PI) for…

  • Puts projects into the same scale & provides a single, easy to read number

    • ΣPV ÷ Cost

    • If PI > 1, what does this imply about NPV?

    • If PI < 1, what does this imply about NPV?

  • Remember:

    • PI = ΣPV ÷ Cost

    • NPV = ΣPV – Cost


Exam 2
Exam #2 for…

  • Tuesday, 2/19/13


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