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Corporate Finance
Crasher
Vishal Lunker
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Capital Budgeting
n The NPV is the sum of the present values of all the expected
incremental cash flows if a project is undertaken.
n A discount rate is the rate one chooses to discount the future
value of your money.
n Note: The discount rate is different than the opportunity cost of
the money. Opportunity cost is a measure of the opportunity
lost. Discount rate is a measure of the risk. These are two
separate concepts.
n Here, rd is the discount rate, and “n” is the number of years in
the future.
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Internal Rate of Return
n For a normal project, the internal rate of return (IRR) is the
discount rate that makes the present value of the expected
incremental after-tax cash inflows just equal to the initial cost
of the project.
PV (inflows) = PV (outflows)
The IRR is also the discount rate for which the NPV of a project
is equal to zero:
n IRR Decision Rule: If IRR > Required rate of return, accept the
project. Else, reject
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PayBack Period & Profitability
Index
n Payback Period: The payback period is the number of years
it takes to recover the initial cost of an investment.
n WACC: Weighted Average Cost of Capital is the rate at which to discount the cash flows
associated with a capital budgeting project.
n Where are weights wi and ki are the associated costs of various types of capital
n After tax cost of debt, cost of preferred stock, cost of common equity
n WACC is reflective of the riskiness of the cash flows of the project. Higher the riskiness,
higher the WACC, lower the NPV.
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Cost of Debt
Cost of Debt
DOL x DFL
n The company's cash balances result from selling goods and
services, collecting receivables, and generating cash from
other sources such as short-term investments.