...Julianne Manchester NPV The NPV method of capital budgeting dictates that all independent projects that have positive NPV should be accepted. The rationale behind that assertion arises from the idea that all such projects add wealth, and that should be the overall goal of the manager in all respects. If strictly using the NPV method to evaluate two mutually exclusive projects, you would want to accept the project that adds the most value (such as the project with the higher NPV). Therefore, if considering Corporations A and B, you would accept both projects if they are independent, and you would only accept Corporation B if they are mutually exclusive. Internal Rate of Return (IRR) The internal rate of return is defined as the discount rate that equates the present value of a project's cash inflows to its outflows. In other words, the internal rate of return is the interest rate that forces NPV to 0. The IRR method of capital budgeting maintains that projects should be accepted if their IRR is greater than the cost of capital. Strict adherence to the IRR method would further dictate that mutually exclusive projects should be chosen on the basis of the greatest IRR. In this scenario, both projects have IRRs that exceed the cost of capital (75%) and both should be accepted, if they are independent. If, however, the projects are mutually exclusive, I would recommend choosing Corporation B. Recall that this was the determination using the NPV method as well. The question...
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...budgeting chapter begins with the time value concepts behind methods and then moves on to computational and decision making techniques. The problems of cash flow estimation and risk encountered in practice are touched upon here in anticipation of a detailed treatment in a later chapter. PEDAGOGY A brief overview of the cost of capital concept is presented early in the chapter even though it is the subject of Chapter 13. The knowledge is necessary to understand and motivate the capital budgeting models. It relates NPV - IRR procedures to the required rate of return idea, something with which students are already familiar. We explicitly tie NPV and IRR together by emphasizing that the IRR comes from the NPV equation as the interest rate that sets NPV=0. This helps to develop an overall understanding of both procedures. TEACHING OBJECTIVES After this chapter students should: 1. appreciate the discounted cash flow basis of capital budgeting theory, and 2. be able to make the computations associated with the major capital budgeting techniques. They should also be marginally aware of the difficulties associated with estimating cash flows and differences in project risk. Along these lines, care should be taken not to form the impression that capital budgeting is an engineering-like process that always gives exactly the right answer. OUTLINE I. CHARACTERISTICS OF BUSINESS PROJECTS The nature of projects requiring capital budgeting...
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...H00112703 INTERNATIONAL BUSINESS MANAGEMENT FRIDAY 08TH MARCH 2012 C38FN 2012-2013 CORPORATE FINANCIAL THEORY WORDCOUNT: 2874 Abstract This essay will discuss the net present value (NPV), payback period (PBP) and internal rate of return (IRR) approaches for a project evaluation. It is often said that NPV is the best approach investment appraisal, which I why I will compare the strengths and weaknesses of NPV as well as the two others to se if the statement is actually true. Introduction To start of, the essay will attempt to explain the theoretical rationale of the net present value approach to investment appraisal as well as its strengths and weaknesses. From there, introduce the payback period method and then internal rate of return approach, as well as to consider their strengths and weaknesses. After outlining and explaining the three different approaches, it will finish up with comparing the different three and in a conclusion. NPV Net present value or NPV is an approach used to determine the value of an investment today (present) compared to the value of the investment in the future after taking the inflation and return into account. In simpler words, it compares the value of 1 pound today with the same pound in the future. Net present value is used in capital budgeting to analyze the profitability of an investment. It is usually calculated using tables and spreadsheets such as Microsoft Excel, but the main formula used to calculate net present value...
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...Alternative Approaches to Valuation of Private Companies 1) 2) 3) 4) 5) Comparables Net Present Value Approach Adjusted Presented Value Approach The ‘Venture Capital’ Method Options Analysis Each approach has advantages and disadvantages. Generally there is no “right” answer to a valuation problem. Valuation is very much an art as much as a science! 1 Evaluation of Comparables How to compute comparables: Start with a sample of securities whose business characteristics are similar to the company being valued. Assume that the company has similar financial ratios to the “comparable” companies. A number of different ratios are typically used: Price/Earnings, Market/Book, Market Value/Sales, EBIT. Then back out the implied value of the company being studied. Comparables Approach relies on two assumptions: Comparable companies have future cash flow expectations and risks similar to the firm being valued Performance measure is actually proportional to value 2 Different ways of Doing Comparables “Comparable Company” – Uses a multiple calculated from the trading values of firms in the same industry as the firm being valued. “Comparable Transaction” – Uses a multiple from companies that were involved in a similar transaction as the firm being valued. “Comparable Industry Transaction” – Uses a multiple from companies from the same industry that were involved in a similar transaction as the firm being valued. 3 Problems with Comparables Approach Generally tough...
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...INTRODUCTION Merck & Company : Evaluating the Licensing Opportunity Various recently-born biotech companies sell their technologies in either finished or early stage to bigger companies in need of financing capital to preceed business, while those bigger companies acquire technologies to scout for promising profitable business. This sort of process needs numbers of decision makings and agreements from both parties on the valuation methods is crucial here. The valuation method being used has to hold objective validity and generality. For the managers to make accurate forecast of future profitability in managing companies, quantified decision making process is needed. Here we are dealing about whether Merck should give financial support to the R&D project of Davanrik offered by LAB, and about the process of valuation and the final decision. First we are to make brief of LAB’s business proposal and practice detailed valuation functions to decide if the proposal is profitable or not. And finally we will make a decision based on the valuation process in perspective of Rich Kender, Vice President of Financial Evaluation & Analysis of Merck. Brief introduction of Merck and its agenda regarding Davanrik project As a world-class pharmaceutical company concentrated on R&Ds, Merck is performing various researches and developments upon medical supplies for human and animals. Merck is providing Pharmaceutical Benefit Management (i.e. PBM) through a company called Merck-Medco...
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... | | 2.2 | Methods and Assumptions | 3 | 3.0 | Capital Expenditure Budget | | | 4 | 4.0 | Investment Analysis | | | 4 | | | 4.1 | Cash flows | 4 | | | 4.2 | NPV Analysis | 5 | | | 4.3 | Rate of Return Calculations | 5 | | | 4.4 | Payback Period Calculations | 5 | 5.0 | Pro Forma Financial Statements | | | 6 | | | 5.1 | Pro Forma Income Statement | 6 | * 1.0 Executive Summary 1.0 Executive Summary * * The Cutting Edge Landscaping is a business that offers specialized crafting and manicuring of lawns in the Miami, Florida area. We bring experience and the option for our customers to customize the lawn of their dreams with the help of our design team. Products offered include: regular lawn servicing, water gardens, fountains, local and exotic plants and flowers. We will give our customers the best curb appeal in Miami. Our professionals will also service light irrigation repair and cleanup post severe inclement weather. * * In the budget plan, we will detail how we intend manage our cash flows while increasing our clients and build a profitable business. * * This budget reflects the operational growth for the first five years our business is in production. The initial investment requirement at startup is $183,095.00 of which a loan for the full amount was invested. We will be able to fully pay this loan back at our discretion within the first five years of business at a lower interest rate. The NPV for the Investment...
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...Contents 1. Assignment Part A Prepare the case, with recommendations to be presented to the Board of Directors of ProGen. Assess the viability of the project using the NPV, IRR, and Payback methods. 2. Assignment Part B “The IRR rule is redundant as an investment criterion because the NPV rule always dominates. Discuss this statement giving examples where possible. 3. Conclusion “The IRR rule is redundant as an investment criterion because the net present value (NPV) rule always dominates it.” 4. Bibliography References Assignment Part A This report evaluates the viability for marketing and distribution of genetically engineered soya seeds developed by a biotechnology firm. The firm will supply seeds and permit ProGen to market and distribute them under a licence. The evaluation methods used for this proposal are net present value (NPV), internal rate of return (IRR), and Payback methods. Assumptions used for this analysis are summarised below • Marketing cost is assumed to be a sunk cost and therefore not included in the calculation • Cash flow will be considered over 5 years as this is the lifecycle of the product • An annual licence fee included at 1M per annum • Capital investment for vehicles £650k is an upfront payment and therefore not discounted • Year 5 will see a cash inflow of 120K assumed a realistic sum...
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...of scope management and financial data analysis for investment decision making. URP consultant is hired by New Jersey department to do projects analysis. The project chosen is Project IHTRHU. Collection of data, detailed analysis, findings and conclusion method has been conducted in providing comprehensive report. However, some data is limited and assumptions are made for sensivity analysis purpose. There are three significant findings based on the scope management plan and financial analysis conducted. On the scope management plan, it has been found that the tracking and monitoring of performance report was lacking as expert advice was not consulted and project scope was not well defined. Findings revealed that among the three projects, Project IHTRHU is the best project due to highest positive NPV rates based on the financial analysis. The discussion analysis comprises IRR, discounted rate, hurdles rate, cash flow, inflation and interest rate for the sole purpose of investment returns. As observed the scope management plan is overall good. Recommendation for improvement on report and tracking performance can be enhanced in avoiding delay and mitigate risk. Also, various financial methods has been used to determine quick cash flow returns. Calculation on NPV is the best recommendation provided based on the exclusive mutually project factor as well as financial analysis views concluded from scholars. Contents Executive Summary…………………………………………………………………………...
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...Assignment front sheet |Qualification |Unit number, title and level | |Pearson BTEC Level 5 HND Diploma in Business (QCF) |Unit 2: Managing Financial Resources and Decisions | | |Level : 4 | |Student name and ID number |Assessor name | | |Simon Masuku | |Interval Verifier |Alan Jeffery | |Date issued |Completion date |Submitted on | |1st May 2015 |3rd July 2015 before 12:00 midday | | |Assignment title |Managing Financial Resources and Decisions - Shaping Your Future – A Vocational Scenario | |LO...
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...conducted an intense, detailed and comprehensive analysis, that included thorough research and exploration into Allegiant Air’s fleet expansion needs. To complete this analysis we compared existing and current market statistics, which pertains specifically to the fleet expansion needs. It is the recommendation of SH&E, that Allegiant Air purchase the McDonnell Douglas MD-80’s at a price of $4,000,000. It is the belief of SH&E, that the purchase of the McDonnell Douglas MD-80’s, is a prudent and sensible decision, versus a price of $62,600,000 for the Airbus A-320. SH&E thorough research showed that given the net present value, also known as NPV, the expenses for the McDonnell Douglas MD-80 is estimated at $44,200,000, in comparison to the Airbus A-320’s NPV of $93,600,000. If Allegiant Air were to purchase the McDonnell Douglas MD-80, over the fifteen year lifespan, this would allow Allegiant Air to save approximately $50,000,000 in operating costs. There is a summary below of the analysis and research that includes the methodology and assumptions that were used to conduct and thus support SH&E’s recommendation. The McDonnell Douglas MD-80 has a different seating capacity than the Airbus A-320.To compare these aircraft, a Cost per Available Seat Mile, also known as CASM, was used as the suitable decision criterion. Another way to think of this comparison is to use an example-for instance, SH&E would never recommend to a bus transportation business or company that...
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...that will be capitalized—in other words, depreciated over time. Remember, a capital expenditure can be many things—a large copying machine, an automated assembly line, a building, or the ultimate in capital budgeting—the acquisition of another entity. What is important about capital budgeting is it allows you to analyze one or more projects so you can intelligently and strategically decide on which project you wish to acquire or which piece of equipment you should procure. There are at least six capital budgeting tools you can use in analyzing a capital expenditure: net present value (NPV), internal rate of return (IRR), profitability index (PI), payback period (PB), discounted payback period (DPB), and modified internal rate of return (MIRR), although the textbook mainly focuses on net NPV and IRR. In a prior finance course, you might have learned how to calculate four of the six tools—NPV, IRR, PI, and PB. If not, then this will be new material for you. Crunching the numbers might seem by some to be the more crucial part—and it is indeed important. However, interpreting and analyzing the answers are just as important. See if you can do this with the six capital budgeting tool answers that you will be computing in the following example. Example Suppose you are thinking of acquiring either the ABC or the XYZ Company. Both have a purchase price of $500K so you cannot readily see which choice would be in your best interest. You also have a capital restraint of approximately...
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...The purpose of this report is to evaluation Wheel Industries on their procedures involving long-term investment opportunities. This report will provide a detailed illustration of the use of several techniques for evaluating capital projects, including the weighted average cost of capital to the firm, the anticipated cash flows for the projects and the methods used for project selection. This report will also include evaluations of two other projects, in detail of the risk of future investments. Scenario: Company Information Wheels Industries is considering a three-year expansion project, Project A. The project requires an initial investment of $1.5 million. The project will use the straight-line depreciation method. The project has no salvage value. It is estimated that the project will generate additional revenues of $1.2 million per year before tax and has additional annual costs of $600,000. The Marginal Tax rate is 35% (Argosy, 2012). We must first start by finding the Depreciation of this project, In order to obtain this we will use the formula: Depreciation = Cost of the asset – salvage value/ Life of the asset. We know that we have no salvage value, so we divide the cost of asset by life of the asset. =1,500,000/ 3 = 500,000 The depreciation is 500,000 per year. The next step is to do a calculation of Cash flows: Revenue- 1,200,000 Less Cost- 600,000 Less Depreciation- 500,000 Profit- 100,000 (income before...
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...management. 2. Explain the benefits of using the net present value (NPV) method to analyze capital expenditure decisions, and be able to calculate the NPV for a capital project. 3. Describe the strengths and weaknesses of the payback period as a capital expenditure decision-making tool, and be able to compute the payback period for a capital project. 4. Explain why the accounting rate of return (ARR) is not recommended for use as a capital expenditure decision-making tool. 5. Be able to compute the internal rate of return (IRR) for a capital project, and discuss the conditions under which the IRR technique and the NPV technique produce different results. 6. Explain the benefits of a postaudit review of a capital project. I. Chapter Outline 10.1 An Introduction to Capital Budgeting A. The Importance of Capital Budgeting • Capital budgeting decisions are the most important investment decisions made by management. • The goal of these decisions is to select capital projects that will increase the value of the firm. • Capital investments are important because they involve substantial cash outlays and, once made, are not easily reversed. • Capital budgeting techniques help management to systematically analyze potential business opportunities in order to decide which are worth undertaking. |Imagine you were to start your own business. No matter what type you started, you would have to answer the following...
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...depreciated over time. Remember, a capital expenditure can be many things -- a large copying machine, an automated assembly line, a building, or the ultimate in capital budgeting -- the acquisition of another entity. What is totally cool about capital budgeting is it allows you to analyze one or more projects so that you can intelligently and strategically make a decision as to which project you wish to acquire or piece of equipment you should procure. There are at least 6 capital budgeting tools that can be used in analyzing a capital expenditure (please note that the text mainly focuses on NPV and IRR) -- Net Present Value (NPV), Internal Rate of Return (IRR), Profitability Index (PI), Payback Period (PB), Discounted Payback Period (DPB), and Modified Internal Rate of Return (MIRR). Perhaps in a prior finance course, you might have learned how to calculate four of the above six tools -- NPV, IRR, PI, and PB. If not, then it will be new material for you! Now, crunching the numbers might seem by some to be the more crucial part -- and it is indeed very important. However, interpreting and analyzing the answers are just as important. Let's see if we can do this with our 6 capital budgeting tool answers that we will be computing in the below example. Now, I am not referring to the sterile text book explanations, but an answer that you could give someone without a finance background that they would understand. Example Let's say that you are thinking of acquiring either the ABC...
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...Notes: FIN 303 Spring 09, Part 7 – Capital Budgeting Professor James P. Dow, Jr. Part 7. Capital Budgeting What is Capital Budgeting? Nancy Garcia and Digital Solutions Digital Solutions, a software development house, is considering a number of new projects, including a joint venture with another company. Digital Solutions would provide the software expertise to do the development, while the other company, American Financial Consultants (AFC) would be responsible for the marketing. Nancy Garcia of Digital Solutions would be responsible for assessing the financial viability of the plan. Information about the costs and revenues of the project would come from the accounting, production and marketing groups of the two companies; however, Ms. Garcia would have to put the information together, and provide a preliminary analysis that she would present to the company’s managers. Capital budgeting is the process of making a decision about the financial desirability of a project. The proposed software development project at Digital Solutions is an example of this kind of problem. We will see how Nancy Garcia approaches this problem as a way to learn the techniques of capital budgeting. The Big Picture Businesses are about increasing the wealth of their owners, which means that they should pursue all the profitable projects that they can. Capital budgeting is about deciding which projects are profitable and add to the value of the firm. Sometimes the firm has to choose between two or...
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