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# Business Finance - PowerPoint PPT Presentation

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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BA303Michael Dimond

…\$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)
• NPV(12,0,{100,200,300,400,500})
Using the calculator (NPV function)
• NPV(9,0,{100,90,80,25},{1,1,1,6})
Project Valuation & Decision Making
• 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)
• 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)
• 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)
• IRR(-1100,{100,200,300,400,500})
Using the calculator (IRR function)
• IRR(-250,{10090,80,25},{1,1,1,6})
Net Present Value (NPV)
• 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 function)
• 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 function)
• 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)
• 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
• Tuesday, 2/19/13