Beruflich Dokumente
Kultur Dokumente
Name
ID
Kamrun Nahar
18256
Swarna Kundu
18183
Debashis Mondal
18121
Sudipta Das
18150
18261
1.
Payback Period
Decision Criteria
If the payback period is less than the
maximum acceptable payback
period,
Accept The Project.
If the payback period is greater than
the maximum acceptable period,
Reject The Project.
Annuity
In case of an annuity, where, there is
a series of equal payments at
regular intervals, the payback period
can be found by Dividing the initial investment by
the annual
cash flow.
Example
25000
25000
25000
25000
25000
-100,000
Project A
Payback period = Initial investment / annual cash flow
= 100,000/ 25000
= 4 years
Limitations
Like the payback period method, it
also ignores the cash flows after the
recovery of initial investment.
Unequal Lives of
Projects
Firms often have to decide between
alternatives that are:
mutually exclusive,
cost different amounts,
have different useful lives, and
require replacement once their productive lives run
out.
We assume that the annual cash flows are the same for each replication.
Total NPV
= 8,367.21 + 8,367.21/(1.10)3 +
8,367.21/(1.10)6 + 8,367.21/(1.10)9
Total NPVB = 8,367.21+ 6,286.41+ 4723.07+ 3,548.51
= 22,925.20
Machine Bs NPV = 22,925.20 > Machine As NPV = 22,210.18
Choose Machine B
Profitability Index
If faced with a constrained budget choose projects
that give us the best bang for our buck.
The Profitability Index can be used to calculate the
ratio of the PV of benefits (inflows) to the PV of the
cost of a project as follows:
PI with standard cash flow = (NPV + Cost) /
Cost
In essence, it tells us how much money we are
getting per taka invested.
Project A
Project B
-10,000
-7,000
5,000
9,000
7,000
5,000
9,000
2,000
NPV @ 10%
7,092.41
6,816.68
Example: PI calculation
Using the cash flows listed in our previous example,
and a discount rate of 10%, calculate the PI of each
project. Which one should be accepted, if they are
mutually exclusive? Why?
PIA = (NPV + Cost)/Cost = (17,092.41/10,000) =
1.71
PIB = (NPV + Cost)/Cost = (13,816.68/7,000) =
1.97
Choose Project B, Higher PI.
WHY IRR
used in capital budgeting to measure profitability and investment.
used to evaluate the desirability of investments or projects.
enables firms capacity to manage projects or investment with IRR
that exceed the cost of capital.
It is an indicator of efficiency, quality and yield of an investment.
Acceptability of an investment is dependent if IRR > the minimum
acceptable rate of return.
comparison between different capital projects is the use of IRR.
ILLUSTRATION
To illustrate the calculation of IRR, consider the cash flows of a project being
considered by TECHTRON LTD
Year
30000
30000
40000
45000
Continue.
(30000/ (1+0.16) ^1) + (30000/ (1+0.16) ^2) + (40000/ (1+0.16) ^3) + (45000/ (1+0.16)
^4) = 98,641.
Since this value is less than 100000, we conclude that the value of r lies between 15 or 16
%.
If a more refined estimate of r is needed, use of the two closest rate of return.
Step 1.
(NPV/ 15%)
802
(NPV/ 16%)
(1359)
Step 2. find the sum of the absolute values of the net present values obtained in step 1:
802+1359= 2161
Step 3. calculate the ratio of the NPV of the smaller discount rate, identified in step 1, to
the sum obtained in step
2:
802/2161= 0.37
Step 4. add the number obtained in step 3 to the smaller discount rate:
15+0.37= 15.37% (IRR).
MODIFIED IRR
TheModified Internal Rate of Return(MIRR) is afinancialmeasure of
aninvestment's attractiveness.It is used incapital budgetingto rank
alternative investments of equal size. As the name implies, MIRR is a
modification of theinternal rate of return(IRR) and as such aims to
resolve some problems with the IRR.
While there are severalproblems with the IRR, MIRR resolves two of them.
Firstly, when the cash flows of the project are not conventional or when
two or more projects are being compared to determine which one is the
best.
Secondly, IRR cannot distinguish between lending and borrowing.
Thirdly, IRR is difficult to apply when short term interest rates differ from
long term interest rates.
finally, more than one IRR can be found for projects with alternating
positive and negative cash flows, which leads to confusion and ambiguity.
MIRR finds only one value.
wherenis the number of equal periods at the end of which the cash
flows occur (not the number of cash flows),PVispresent value(at the
beginning of the first period),FVis future value(at the end of the last
period).
illustration
Year
(4000)
5000
2000
In this case, the answer is 25.48% (with this conventional pattern of cash flows,
the project has a unique IRR).
To calculate the MIRR, we will assume a finance rate of 10% and a reinvestment
rate of 12%. First, we calculate the present value of the negative cash flows
(discounted at the finance rate):
CONT
Second, we calculate the future value of the positive cash flows (reinvested
at the reinvestment rate):
The calculated MIRR (17.91%) is significantly different from the IRR (25.48%).
EVALUATION
MIRR is superior to the IRR in two ways:
1.MIRR assumes that projects cash flows are reinvested
at the cost of capital whereas IRR assumes that project
cash flows are reinvested at the projects own IRR.
2.The problem of multiple rates does not exist with MIRR.
Thus, MIRR is a distinct improvement over the regular
IRR.
It is as good as NPV in choosing mutually exclusive
projects.
INCREMENTAL ANALYSIS
a technique or approach that can be used with NPW,
EAW and later with IRR and cost/ benefit to determine
if an incremental expenditure should be made.
Incremental analysis can also be used when you
are already incurring an expense.
(e.g; DSL internet service)
and you are trying to determine if it is a good
decision to spend additional funds.(e.g; satellite or
cable)
Project A requires $50 000 upfront to obtain an IRR of 35% per year.
Project B requires an $85 000 first cost and returns an IRR of 29% per
year.
since income and investment can be measured in different ways, there can
be a very large number of measures for ARR.
MEASURES OF ARR
A.Average
B.Average
C.Average
D.Average
income
income
income
income
after
after
after
after
SHORTCOMINGS ARE:
1.It is based upon accounting profit, not cash flow
2.It does not take into account the time value of money.
EVALUATION:
the higher the ARR, the better the project.
In general ARR > pre specified cut off rate of return(between
15 & 30%) are accepted, others are rejected.
. The computation of various measures of ARR with
reference to a hypothetical project.
Please see exhibit 8.10, chapter 8, PRASANNA CHANDRA,
PROJECTS.
Economic Analysis
A systematic approachto determining the
optimum use of scarce
resources. It takes
intoaccounttheopportunity costsof
resourcesemployedandattemptstomea
sureinmonetaryterms the private
andsocial costs andbenefits of
aprojectto the community or economy.
Cost benefit
analysis(CBA)
Cost Effective
Analysis(CEA)
Cost Utility
Analysis(CUA)
Purpose of CBA
A CBA has two purposes:
1. To determine if the project or
decision is a sound.
2. To provide a basis for comparing
projects or decisions. It involves
comparing the total expected cost of
each option against the total
expected benefits.
Principles of CBA
Common unit of measurement
Representation of customers or
producers valuation
Benefit measurement by market
choice
No double counting of benefits or
costs
Some measurement of benefit may
consider human factor
Net benefit
= benefit/ cost
=160000/11400
0
=1.40
>0
ACCEPT
=0
=O
INDIFFERENT
<1
<0
REJECT
CBA Vs CEA
CBA
CEA
Considers only
monetary value of
output.
Highly used in
industrial or technical
sector.
Focus on monetary
value.
Cost is a denominator
Considers both
monetary and non
monetary value of
output.
Highly used in
Training and personnel
programs.
Focus on no of units.
Cost is a numerator
Math on CEA
Albert healthcare
Intervention
QALY Gained
Net Cost
20
$500
30
$2000
25
$1000
Intervention
QALY Gained
Net Cost
20
$500
25
$1000
30
$2000
CE ratio
Intervention
QALY Gained
Net Cost
per
day(effectiven
ess)
CE ratio
(Net Cost/QALY
Gained)
20
$500
$25
25
$1000
$50
30
$2000
$67
ICER
Shipment to new option(From X to Z)
incremental cost = (Cost Z Cost X) = $1000-$500
= $500
incremental benefit = (QALYs Z QALYs X) = 25
QALYs -20 QALYs = 5 QALYs
Mathematical Problem
CALCULATION
NET PRESENT VALUE
EAA =
Decision Rule
Application
Assessing alternative projects of unequal lives.
Determining the optimum economic life of an asset.
Assessing whether leasing an asset would be more economical than
purchasing it.
of an asset.
APPLICATION
equipment.
asset.
0
1
(150000 500000
0)
Accelerate (800000 800000
)
2
600000
3
800000
4
300000
5
200000
200000
Solution:
Outback
Accelerate
Present
value
Cash flows 8%
discount
factor
(15,000,00
0)
1.0000
(15,000,00 (8,000,000
0)
)
5000,000
0.9091
4545500
6,000,000
0.8264
8,000,000
3,000,000
2,000,000
0.7513
0.6830
0.6209
NPV
year
Present
value
1.0000
(8,000,000
)
8,000,000
0.9259
7,407,407
4,958,678
2,000,000
0.8573
1,714,678
6,010,518
2,049,040
1,241,843
3,805,534
NPV
1,122,085
3
4
5
The second step involves finding the cash flows occurring at each
year end that would equal the relevant net present value when
discounted at the relevant discount rate.
EAA(Outback)=
3805534
(1-(1+10%)^5)/10%
EAA(Accelerate)=
629231
1003890
1122085
(1-(1+8%)^2/8%
Since Outback has higher equivalent annual annuity, it is the clear winner. The company
should work on Outback.
Machine A
Machine B
Investment cost
$50,000
$150,000
Expected lifetime
3 years
8 years
$7,500
150000/A8,5+7500=30708
50000/A3,5+13000= 31360
Cost of capital is 5%
EXAMPLE
For example, the opportunity to invest in the
expansion of a firm's factory, or alternatively to sell
the factory, is a realcallorput option, respectively.
Real options analysis, as a discipline, extends from
its application incorporate finance, todecision
making under uncertaintyin general, adapting the
techniques developed for financial optionsto "reallife" decisions.
OPTION CHARACTERISTICS
1)strike price
2)Option term
3)Option style & option exercise:
Option to contract
Option to abandon
Option to extract
EXAMPLES
R&Dmanagers can use Real
Options Valuation to help them
allocate their R&D budget among
diverse projects;
a non business example might
be the decision to join the work
force, or rather, to forgo several
years of income to
attendgraduate school
"Investment
Example"
Consider a firm that has the option to
invest in a new factory. It can invest
this year or next year. The question
is: when should the firm invest? If the
firm invests this year, it has an
income stream earlier. But, if it
invests next year, the firm obtains
further information about the state of
the economy, which can prevent it
from investing with losses.
EXAMPLE CONT
Investment Example
Stage investment
SWITCHING VALUE/COST
Switching costs are the negative costs that a consumer incurs as a
result of changing suppliers,brandsor products.
It may be..
Inmutual funds, the process of transferring an investment from one
fund to another.
In securities, the process of liquidating a position in exchange for
other securities with better prospects for growth, yields orcapital
gains.
Cont..
1.Investors mayswitchtheir assets between funds in
the same family or into a different family entirely.
Switching cost:
Multinational Capital
Budgeting
Like domestic capital budgeting, this focuses
on the cash inflows and outflows associated
with prospective long-term investment projects
Capital budgeting follows same framework as
domestic budgeting
Identify initial capital invested or put at risk
Estimate cash inflows, including a terminal value or
salvage value of investment
Identify appropriate discount rate for PV calculation
Apply traditional NPV or IRR analysis
Although
price/cost
forecasting
implicitly
considers
inflation, inflation can be quite
volatile from year to year for some
countries.
is no incremental debt
is no incremental depreciation
are no concessionary loans
are no restricted funds
200
500
300
$1.25
The current exchange rate is S0($/) =
200
500
300
$1.25 = $750
CF0 = (600) S0($/) =(600)
$257.28
200
500
300
S1($/) = 1 + S0($/) =
= $1.2864/
1.03
$257.28
200
$661.94
500
300
CF2=
1.06
1.03
1.06
1.03
$1.25
500 = $661.94
$257.28
200
$661.94
500
CF3=
1.06
1.03
1.06
1.03
1.06
1.03
$408.73
300
$1.25
300 = $408.73
$257.28
$661.94
$408.73
Find the NPV using the cash flow @ interest rate i$ = 15%:
CF0 = $750
CF1 = $257.28
CF2 = $661.94
CF3 = $408.73
= 15
NPV = $242.99
200
500
300
= 3%
i$ = 15%
(1 + e) (1 + $) = (1 + i$)
real
rate
inflation
rate
nominal
rate
(1 + e) =
(1 + i$)
(1 + $)
(1 + e$) =
(1 + i$)
(1 + $)
and
(1 + e) =
(1 + i)
(1 + )
If the real rates are the same in dollars and euros (e = e$)
(1 + i$)
(1 + $)
(1 + i)
(1 + )
(1 + i$)
(1 + $)
(1 + i)
(1 + )
(1 + i) =
i =
(1.15) (1.03)
(1.06)
(1 + i$) (1 + )
(1 + $)
1
i = 0.1175
200
500
300
Find the NPV using the cash flow menu and i = 11.75%:
CF0 = 600
CF1 = 200
CF2 = 500
CF3 = 300
= 11.75
NPV = 194.39
$1.25 = $242.99
194.39
600
200
500
300
1
3
2
200
500
300
=
194.39
+
+
NPV = 600 +
1.1175
(1.1175)2
(1.1175)3
$750
$257.28
194.39
$1.25 = $242.99
$661.94
$408.73
1
3
2
$257.28 $661.94
$408.73
= $242.99
+
+
NPV = $750 +
2
3
1.15
(1.15)
(1.15)
International Capital
Budgeting
We have two equally valid approaches:
Change the foreign cash flows into dollars at
the exchange. Find the $NPV using the
dollar cost of capital.
Find the foreign currency NPV using the
foreign currency cost of capital. Translate
that into dollars at the spot exchange rate.
Computing IRR
Recall that a projects Internal Rate of
Return (IRR) is the discount rate that
gives a project a zero NPV.
NPV = 600 +
200
1+IRR
IRR = 28.48%
NPV = $750 +
$257.28
1+IRR$
IRR$ = 32.23%
18-113
500
(1+IRR)
$661.94
(1+IRR$)
300
(1+IRR)
$408.73
(1+IRR$)
= 0
= $0
Computing IRR
Easily done with the IRR key
NPV = 600 +
CF0 = 600
200
1+IRR
500
(1+IRR)
300
(1+IRR)
CF2 = 500
18-114
= 0
IRR = 28.48%
CF1 = 200
CF3 = 300
IRR = 28.48%
Computing IRR
Easily done with the IRR key
NPV = $750 +
$257.28
1+IRR$
CF0 = $750
$661.94
(1+IRR$)
$408.73
(1+IRR$)
CF2 = $661.94
18-115
= $0
IRR$ = 24.85%
CF1 = $257.28
CF3 = $408.73
IRR = 32.23%
1+IRR$
(1 + $)
(1+IRR$) =
1+IRR
(1 + )
(1+IRR)(1 + $)
(1 + )
= 3%, $ = 6%
18-116
i =
(1.2848)(1.06)
(1.03)
IRR$ = 32.23%
1+IRR$
(1 + $)
(1+IRR$) =
1+IRR
(1 + )
(1+IRR)(1 + $)
(1 + )
= 3%, $ = 6%
18-117
i =
(1.2848)(1.06)
(1.03)
IRR$ = 32.23%
Q&A