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Principles of Managerial Finance 9th Edition

Principles of Managerial Finance 9th Edition. Chapter 9. Capital Budgeting Techniques. Learning Objectives. Understand the role of capital budgeting techniques in the capital budgeting process. Calculate, interpret, and evaluate the payback period.

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Principles of Managerial Finance 9th Edition

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  1. Principles of Managerial Finance9th Edition Chapter 9 Capital Budgeting Techniques

  2. Learning Objectives • Understand the role of capital budgeting techniques in the capital budgeting process. • Calculate, interpret, and evaluate the payback period. • Calculate, interpret, and evaluate the net present value (NPV). • Calculate, interpret, and evaluate the internal rate of return (IRR).

  3. Learning Objectives • Use the net present value profiles to compare net present value and internal rate of return techniques. • Discuss NPV and IRR in terms of conflicting rankings and the theoretical and practical strengths of each approach.

  4. Techniques that Ignore the Time Value of Money • Payback. The payback method simply measures how long (in years and/or months) it takes to recover the initial investment. • But payback has two major weaknesses: • First, it fails to consider the importance of the time value of money. • Second, it fails to consider cash flows that occur after the pre-set payback period.

  5. Techniques that Ignore the Time Value of Money • Payback Weakness: Failure to consider the time value of money (pattern of cash flows). But which is preferred? Payback is the same!

  6. Techniques that Ignore the Time Value of Money • Payback Weakness: Failure to consider all relevant cash flows. But look at the total cash flows for Project 1! Payback says pick Project 2!

  7. Time Value Techniques • Net Present Value (NPV). Net Present Value is found by subtracting the present value of the after-tax outflows from the present value of the after-tax inflows. Decision Criteria If NPV > 0, accept the project If NPV < 0, reject the project If NPV = 0, indifferent

  8. Time Value Techniques Net Present Value Recall the Net Incremental Cash Flows for East Coast Drydock from Chapter 8

  9. Time Value Techniques Net Present Value With a 15% discount rate, we would keep the existing hoist

  10. Time Value Techniques Net Present Value In fact, even with a discount rate of 0%, we would keep the existing hoist since it has the highest NPV.

  11. Time Value Techniques Net Present Value Recall that the before tax operating cash inflows for Drydock in Chapter 9 were as follows:

  12. Time Value Techniques Net Present Value What if -- because of a measurement error -- the cash inflows for A and B were double those initially estimated as shown below:

  13. Time Value Techniques Net Present Value 此資料由第一期計算,財務計算機則由第零期計算 Recalculating the NPV at a discount rate of 15%, we get: The Excel function for computing NPV is =NPV(int rate, data range)

  14. Time Value Techniques Net Present Value With the new numbers, we can now see that Hoist B should be used to replace the existing hoist. This will maximize NPV and ultimately, shareholder value.

  15. Time Value Techniques Internal Rate of Return • The IRR is the discount rate that will equate the present value of the outflows with the present value of the inflows: • The IRRis the project’s intrinsic rate of return. Decision Criteria If IRR > k, accept the project If IRR < k, reject the project If IRR = k, indifferent

  16. Time Value Techniques Internal Rate of Return Note that both replacement projects provide a return in excess of the cost of capital of 15%. 無法計算其IRR 此資料由第零期計算,財務計算機也由第零期計算 The Excel function for computing IRR is =IRR(data range)

  17. Time Value Techniques Internal Rate of Return What if the cost of capital were 42.19%? Notice that for Hoist B, IRR = the discount rate and that NPV = 0

  18. IRR的應用 • 元智大學提供教職員優惠的年金保險,參加人員每年將依個人服務年資由學校補助一萬五仟元(服務十年以上)、一萬元(服務六至九年)及伍仟元(服務五年以下)。根據該保險經紀人公司的試算結果,去計算該項年金保險的內部報酬率:假設現年三十九歲女性教職員,本校服務年資兩年,首欄的數字為連續十年繳納年金保險費(扣除掉5%的單利以及學校提撥的金額),於第十八年時全數領出;次欄的數字為連續十年繳納年金保險費(扣除掉5%的單利以及學校提撥的金額),於第十九年時全數領出。兩者用EXCEL計算出來的內部報酬率(IRR)都是6%,遠高於現行市場上任何的定存利率。

  19. Time Value Techniques Net Present Value Profile The NPV Profile shows how a project’s value changes with changes in the discount rate.

  20. Time Value Techniques Net Present Value Profile 只有當K大於這點時,NPV與IRR的決策是一致的 47.63% 42.19%

  21. Time Value Techniques PI = PV Inflows PV Outflows Decision Criteria If PI > 1, accept the project If PI < 1, reject the project If PI = 1, indifferent Profitability Index • The profitability index which is also sometimes called the benefit/cost ratio, is the ratio of the present value of the inflows to the present value of the outflows.

  22. Time Value Techniques Double A和B的cash flow後 Profitability Index Returning to the last East Coast Drydock example, we get: Choose Hoist A since PIA > PIB

  23. Problems with Discounted Cash Flow Techniques Conflicting Rankings for Mutually Exclusive Projects Mutually exclusive projects compete in some way with the same resources. A firm can pick one, or the other, but not both.

  24. Problems with Discounted Cash Flow Techniques Conflicting Rankings for Mutually Exclusive Projects Mutually exclusive projects compete in some way with the same resources. A firm can pick one, or the other, but not both.

  25. Problems with Discounted Cash Flow Techniques Conflicting Rankings for Mutually Exclusive Projects NPV If k<e If e<k<f If k>f 兩個project的IRR皆為36% 亦即NPV=0時的K皆為36% k(%) e f g A B 若AB為mutually exclusive,則當k<36%時,選A 當k>36%時,都不要 若AB為Independent,當k<36%,2者都選 當k>36%,都不要 36%

  26. Problems with Discounted Cash Flow Techniques Conflicting Rankings for Mutually Exclusive Projects • Interdependent projects are those that influence the value of others. • In general terms, if there are two interdependent projects, then three appraisals are required: • Project A • Project B • And Project A plus B 如:兩家鄰近的購物中心

  27. Problems with Discounted Cash Flow Techniques Summary • If projects are mutually exclusive and not subject to capital rationing, the project with the higher NPV should be selected. • If the projects are independent, and there is no capital restriction, both should be chosen if they have positive NPVs. • In the presence of capital restrictions, the project with the higher NPV should be selected.

  28. -170,000 +52,000 +78,000 +100,000 0 1 2 3

  29. -170,000 +52,000 +78,000 +100,000 0 1 2 3 248,720 和上頁相同 和上頁相同

  30. 基本上:greater the difference between the magnitude and timing of cash inflows, the greater the likelihood of conflicting rankings between NPV and IRR. 理論上:用NPV,不要用IRR。因為(1)NPV假設intermediate cash flows are reinvested at cost of capital,IRR則假設intermediate cash flows are reinvested at IRR。NPV法的假設較為合理且保守。(2)non-conventional cash flow常會有多重或零個IRR的解 實務上:業界仍偏好IRR 若期初投資一樣的話 WHY?因為晚期的Cash flow會被高折現率severely penalized in present value terms.

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