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Managerial Finance

Managerial Finance. Net Present Value (NPV) Week 5. Some assumptions for project. Bank wants at least 8% (unless you have other information from an acceptable source) Bank will not fund more than 70% of capital investment Tax rate come from Hotel I/S

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Managerial Finance

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  1. Managerial Finance Net Present Value (NPV) Week 5

  2. Some assumptions for project • Bank wants at least 8% (unless you have other information from an acceptable source) • Bank will not fund more than 70% of capital investment • Tax rate come from Hotel I/S • Shareholders usually require upwards of 15% return

  3. Today’s Topics • Product & Economic Lifecycles (Evaluating Your Project Over Time) • Depreciation • Cash Flow • Time Value and Discount Rate • Risk • Inflation

  4. What’s in the future ?

  5. What’s in the future ? How will these numbers change over the years? What factors will affect them? • Product Life Cycle • Economic Life Cycle • Inflation

  6. The Role of Time Value in Finance Most financial decisions involve costs & benefits that are spread out over time. Understanding the Time Value of Money allows comparison of cash flows from different periods.

  7. Question: Your father has offered to give you some money and asks that you choose one of the following two alternatives: • €10.000 today, or • €13.310 three years from now. • What do you do?

  8. Time Line

  9. Simple Interest With simple interest, you don’t earn interest on interest. Year 1: 5% of $100 = $5 + $100 = $105 Year 2: 5% of $100 = $5 + $105 = $110 Year 3: 5% of $100 = $5 + $110 = $115 Year 4: 5% of $100 = $5 + $115 = $120 Year 5: 5% of $100 = $5 + $120 = $125

  10. Compound Interest With compound interest, a depositor earns interest on interest! Year 1: 5% of $100.00 = $5.00 + $100.00 = $105.00 Year 2: 5% of $105.00 = $5.25 + $105.00 = $110.25 Year 3: 5% of $110.25 = $5 .51+ $110.25 = $115.76 Year 4: 5% of $115.76 = $5.79 + $115.76 = $121.55 Year 5: 5% of $121.55 = $6.08 + $121.55 = $127.63

  11. Compounding andDiscounting

  12. Future Value of a Single Amount If Andreas places $100 in a savings account paying 8% interest compounded annually, how much will he have in the account at the end of one year? $100 x (1.08)1 = $100 x (1.08) $100 x 1.08 = $108

  13. Future Value of a Single Amount: The Equation for Future Value Tobias places €800 in a savings account paying 6% interest compounded annually. He wants to know how much money will be in the account at the end of five years. FV5 = €800 X (1 + 0.06)5 = $800 X (1.338) = €1,070.40

  14. Future Value of a Single Amount:A Graphical View of Future Value Future Value Relationship

  15. Present Value of a Single Amount Luisa has an opportunity to receive $300 one year from now. If she can earn 6% on her investments, what is the most she should pay now for this opportunity? $300 x [1/(1+i)n] = $300 x [1/(1.06)1]= $300 x 0.9434 = $283.02

  16. Money is worthmoretoday than tomorrow The Time Value of Money

  17. Present Value of a Single Amount: The Equation for Future Value Feline wishes to find the present value of $1,700 that will be received 8 years from now. Feline’s opportunity cost is 8%. PV = FV/(1+i)n = $1,700/(1 + 0.08)8 = $1,700/1.851 = $918.42

  18. Present Value of a Single Amount: A Graphical View of Present Value Present Value Relationship

  19. Present Value of a Mixed Stream Kings Island Team has been offered an opportunity to receive the following mixed stream of cash flows over the next 5 years.

  20. Present Value of a Mixed Stream If the firm must earn at least 9% on its investments, what is the most it should pay for this opportunity?

  21. Calculate your project’s relevant cash flows

  22. Excluding Interest, because WACC is the discount factor!!! How will these numbers change over the years? What factors will affect them?

  23. Equity Debt rWACC = × rEquity + × rDebt ×(1 – Tx) Equity + Debt Equity + Debt WACC BUT WHAT ABOUT INFLATION???? Already captured in returns on debt/equity

  24. WACC = 12%PLC = 3 YearsInvestment = € 100,000

  25. WACC = 12%PLC = 3 YearsInvestment = € 100,000

  26. WACC = 12%PLC = 3 YearsInvestment = € 100,000

  27. WACC = 12%PLC = 3 YearsInvestment = € 100,000

  28. Present Value Sum = Present Value € 119,465

  29. NET Present Value Sum = Net Present Value € 19,465

  30. PV & NPV Present Value of Cash Flow € 119,465 Minus Investment (100,000) Net Present Value (NPV) € 19,465

  31. PI & PP • Profitability Index • Payback Period • Limitations of these methods • Decision criteria

  32. Good luck!

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