© 2013 Pearson Education, Inc. All rights reserved.9-1 Additional Problems with Answers Problem 1 Computing Payback Period and Discounted Payback Period.

Slides:



Advertisements
Similar presentations
Principles of Managerial Finance 9th Edition
Advertisements

Chapter 9 Capital Budgeting Techniques
Net Present Value and Other Investment Rules Chapter 5 Copyright © 2010 by the McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin.
Capital Budgeting Decision Models
Chapter 9 - Capital Budgeting Decision Criteria. Capital Budgeting: The process of planning for purchases of long- term assets.  For example: Suppose.
Chapter 10 Capital-Budgeting Techniques and Practice.
Capital Budgeting 9-1. LEARNING OBJECTIVES 1. Explain capital budgeting and differentiate between short-term and long-term budgeting decisions. 2. Explain.
Copyright © 2003 Pearson Education, Inc. Slide 9-0 Chapter 9 Capital Budgeting Techniques.
McGraw-Hill/Irwin Copyright © 2013 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin Copyright © 2013 by The McGraw-Hill Companies,
Intro to Financial Management Capital Budgeting. Review Homework Cost of bonds –Use net proceeds –Use after-tax cost Cost of common stock –Use net proceeds.
Key Concepts and Skills
11-1 CHAPTER 11 The Basics of Capital Budgeting Should we build this plant?
Capital Investment Decisions
Copyright © 2010 Pearson Prentice Hall. All rights reserved. Chapter 9 Capital Budgeting Decision Models.
1 The Basics of Capital Budgeting: Evaluating and Estimating Cash Flows Corporate Finance Dr. A. DeMaskey Should we build this plant?
Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin 0 Chapter 8 Net Present Value and Other Investment Criteria.
Chapter 9 Capital Budgeting Techniques. Copyright © 2006 Pearson Addison-Wesley. All rights reserved. 9-2 Learning Goals 1.Understand the role of capital.
4-1 Business Finance (MGT 232) Lecture Capital Budgeting.
Chapter 9 Net Present Value and Other Investment Criteria
CHAPTER 10 The Basics of Capital Budgeting 1. Payback Period 2. Discounted Payback 3. Net Present Value (NPV) 4. Internal Rate of Return (IRR) 5. Modified.
Chapter 10 - Capital Budgeting
Chapter 9 INVESTMENT CRITERIA Pr. Zoubida SAMLAL GF 200.
Net Present Value RWJ-Chapter 9.
© 2003 The McGraw-Hill Companies, Inc. All rights reserved. Net Present Value and Other Investment Criteria Chapter Nine.
Chapter 6 Capital Budgeting Techniques © 2005 Thomson/South-Western.
Capital Budgeting Problems
10-1 CHAPTER 10 The Basics of Capital Budgeting Should we build this plant?
CHAPTER 10 The Basics of Capital Budgeting Omar Al Nasser, Ph.D. FIN
T9.1 Chapter Outline Chapter 9 Net Present Value and Other Investment Criteria Chapter Organization 9.1Net Present Value 9.2The Payback Rule 9.3The Discounted.
Capital Budgeting (I): Different Approaches (Ch 9) Net Present Value The Payback Rule The Discounted Payback The Average Accounting Return The Internal.
CAPITAL BUDGETING AND CAPITAL BUDGETING TECHNIQUES FOR ENTERPRISE Chapter 5.
Chapter 9 Capital Budgeting Decision Models. © 2013 Pearson Education, Inc. All rights reserved.9-2 Learning Objectives 1.Explain capital budgeting and.
McGraw-Hill /Irwin Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved. May 31 Capital Budgeting Decisions.
© 2003 The McGraw-Hill Companies, Inc. All rights reserved. Net Present Value and Other Investment Criteria Chapter Nine.
T9.1 Chapter Outline Chapter 9 Net Present Value and Other Investment Criteria Chapter Organization 9.1Net Present Value 9.2The Payback Rule 9.3The Discounted.
T9.1 Chapter Outline Chapter 9 Net Present Value and Other Investment Criteria Chapter Organization 9.1Net Present Value 9.2The Payback Rule 9.3The Average.
Capital Budgeting Decision Models
Capital Budgeting and Investment Analysis
Lecture Nine – Capital Budgeting
Chapter 12 The Capital Budgeting Decision. McGraw-Hill/Irwin © 2005 The McGraw-Hill Companies, Inc., All Rights Reserved. PPT 12-1 FIGURE 12-1 Capital.
Capital Budgeting Decisions. What is Capital Budgeting? The process of identifying, analyzing, and selecting investment projects whose returns (cash flows)
11-1 CHAPTER 11 The Basics of Capital Budgeting Should we build this plant?
8- 1 McGraw Hill/Irwin Copyright © 2009 by The McGraw-Hill Companies, Inc. All rights reserved Chapter 8 Net Present Value and Other Investment Criteria.
Unit 4 – Capital Budgeting Decision Methods
Business Finance (MGT 232)
Capital Budgeting. Definition Capital budgeting is the planning process used to determine whether a firm's long term investments such as new machinery,
The Capital Budgeting Decision Chapter 12. Chapter 12 - Outline What is Capital Budgeting? 3 Methods of Evaluating Investment Proposals Payback IRR NPV.
10-1 CHAPTER 11 The Basics of Capital Budgeting Should we build this plant?
T9.1 Chapter Outline Chapter 9 Net Present Value and Other Investment Criteria Chapter Organization 9.1Net Present Value 9.2The Payback Rule 9.3The Discounted.
©2012 McGraw-Hill Ryerson Limited 1 of 45 Learning Objectives 1.Define capital budgeting decisions as long-run investment decisions. (LO1) 2.Explain that.
13-1 Agenda for 30 July (Chapter 9) Assessment of various commonly used methods for deciding how capital is to be allocated. Net Present Value (NPV) The.
Capital Budgeting Decision-making Criteria
Net Present Value and Other Investment Criteria By : Else Fernanda, SE.Ak., M.Sc. ICFI.
Capital Budgeting: Decision Criteria
Basics of Capital Budgeting. An Overview of Capital Budgeting.
Capital Budgeting Decision Methods 1. Learning Objectives The capital budgeting process. Calculation of payback, NPV, IRR, and MIRR for proposed projects.
 2005, Pearson Prentice Hall Chapter 9 - Capital Budgeting Decision Criteria.
ALL RIGHTS RESERVED No part of this document may be reproduced without written approval from Limkokwing University of Creative Technology 1-1 Chapter 8.
CAPITAL BUDGETING DECISIONS CHAPTER Typical Capital Budgeting Decisions Plant expansion Equipment selection Equipment replacement Lease or buy Cost.
Chapter 9 Investment Decision Rules and Capital Budgeting.
Chapter 26 Capital Investment Decisions Demonstration Problems © 2016 Pearson Education, Inc.26-1.
10-1 CHAPTER 10 The Basics of Capital Budgeting What is capital budgeting? Analysis of potential additions to fixed assets. Long-term decisions;
Welcome Back Atef Abuelaish1. Welcome Back Time for Any Question Atef Abuelaish2.
L7 - Capital Budgeting Decision Models
CHAPTER 11 The Basics of Capital Budgeting
Net Present Value Bobby Strozak Steve Johnson.
Capital Budgeting Decision Models
Chapter 7 - Capital Budgeting Decision Criteria
Capital-Budgeting Techniques.
Net Present Value and Other Investment Criteria
Presentation transcript:

© 2013 Pearson Education, Inc. All rights reserved.9-1 Additional Problems with Answers Problem 1 Computing Payback Period and Discounted Payback Period. Regions Bank is debating between two the purchase of two software systems; the initial costs and annual savings of which are listed below. Most of the directors are convinced that given the short lifespan of software technology, the best way to decide between the two options is on the basis of a payback period of 2 years or less. Compute the payback period of each option and state which one should be purchased. One of the directors states, “I object! Given our hurdle rate of 10%, we should be using a discounted payback period of 2 years or less.” Accordingly, evaluate the projects on the basis of the DPP and state your decision.

© 2013 Pearson Education, Inc. All rights reserved.9-2 Additional Problems with Answers Problem 1 (Answer) Payback period of Option A = 1 year + (1,875,000-1,050,000)/900,000 = 1.92 years Payback period of Option B = 1year + (2,000,000-1,250,000)/800,000 = years. Based on the Payback Period, Option A should be chosen.

© 2013 Pearson Education, Inc. All rights reserved.9-3 Additional Problems with Answers Problem 1 (Answer) (continued) For the discounted payback period, we first discount the cash flows at 10% for the respective number of years and then add them up to see when we recover the investment. DPP A = -1,875, , ,801.65=  still to be recovered in Year 3  DPP A = 2 + ( / ) = 2.52 years DPP B = -2,000,000+1, 136, =  still to be recovered in Year 3  DPP B = 2 + ( / ) = 2.45 years. Based on the Discounted Payback Period and a 2 year cutoff, neither option is acceptable.

© 2013 Pearson Education, Inc. All rights reserved.9-4 Additional Problems with Answers Problem 2 Computing Net Present Value – Independent projects: Locey Hardware Products is expanding its product line and its production capacity. The costs and expected cash flows of the two projects are given below. The firm typically uses a discount rate of 15.4 percent. a.What are the NPVs of the two projects? b.Which of the two projects should be accepted (if any) and why?

Additional Problems with Answers Problem 2 (Answer) = $86, $20, Decision: Both NPVs are positive, and the projects are independent, so assuming that Locey Hardware has the required capital, both projects are acceptable.

© 2013 Pearson Education, Inc. All rights reserved.9-6 Additional Problems with Answers Problem 3 KLS Excavating needs a new crane. It has received two proposals from suppliers. Proposal A costs $ 900,000 and generates cost savings of $325,000 per year for 3 years, followed by savings of $200,000 for an additional 2 years. Proposal B costs $1,500,000 and generates cost savings of $400,000 for 5 years. If KLS has a discount rate of 12%, and prefers using the IRR criterion to make investment decisions, which proposal should it accept?

© 2013 Pearson Education, Inc. All rights reserved.9-7 Additional Problems with Answers Problem 3 (Answer)

© 2013 Pearson Education, Inc. All rights reserved.9-8 Additional Problems with Answers Problem 4 Using MIRR. The New Performance Studio is looking to put on a new opera. They figure that the set-up and publicity will cost $400,000. The show will go on for 3 years and bring in after- tax net cash flows of $200,000 in Year 1; $350,000 in Year 2; -$50,000 in Year 3. If the firm has a required rate of return of 9% on its investments, evaluate whether the show should go on using the MIRR approach.

© 2013 Pearson Education, Inc. All rights reserved.9-9 Additional Problems with Answers Problem 4 (Answer) The forecasted after-tax net cash flows are as follows: Year After-tax cash flow 0 -$400, , , $50,000 The formula for MIRR is as follows: Where : FV = Compounded value of cash inflows at end of project’s life (Year 3)using realistic reinvestment rate (9%); PV = Discounted value of all cash outflows at Year 0; N = number of years until the end of the project’s life= 3.

© 2013 Pearson Education, Inc. All rights reserved.9-10 Additional Problems with Answers Problem 4 (Answer) (continued) FV 3 = $200,000*(1.09) 2 + $350,000*(1.09) 1 = $237,620 + $381,500 = $619,120 PV 0 = $400,000 + $50,000/(1.09) 3 =$438, MIRR = (619,120/$438,609.17) 1/ 3 – 1 = ( ) 1/3 -1 = 12.18% The show must go on, since the MIRR = 12.18% > Hurdle rate = 9%

© 2013 Pearson Education, Inc. All rights reserved.9-11 Additional Problems with Answers Problem 5

© 2013 Pearson Education, Inc. All rights reserved.9-12 Additional Problems with Answers Problem 5 (Answer) To get some idea of the range of discount rates we should include in the NPV profile, it is a good idea to first compute each project’s IRR and the crossover rate, i.e., the IRR of the cash flows of Project B-A as shown below:

© 2013 Pearson Education, Inc. All rights reserved.9-13 Additional Problems with Answers Problem 5 (Answer) (continued) So, it’s clear that the NPV profiles will cross- over at a discount rate of 5.2%. Project A has a higher IRR than Project B, so at discount rates higher than 5.2%, it would be the better investment, and vice-versa (higher NPV and IRR), but if the firm can raise funds at a rate lower than 5.2%, then Project B will be better, since its NPV would be higher. To check this let’s compute the NPVs of the 2 projects at 0%, 3%, 5.24%, 8%, 10.2%, and 11.6%...

© 2013 Pearson Education, Inc. All rights reserved.9-14 Additional Problems with Answers Problem 5 (Answer) (continued) Note that the two projects have equal NPVs at the cross-over rate of 5.24%. At rates below 5.24%, Project B’s NPVs are higher; whereas at rates higher than 5.24%, Project A has the higher NPV.