1. Business Finance
Michael Dimond

2. Discounting unequal cash flows
If you require a 12% annual return, what would you pay for…
…$90 to be delivered in 1 year? ($ )
…$95 to be delivered in 2 years? ($ )
…$99 to be delivered in 3 years? ($ )
…all of the above?
By adding together the present values, you find the value of all the cash flows in the stream.
i = 12% 1 2 3 ? 90 95 99
90 ÷ (1+0.12)1
There’s an easier way… kind of.
95 ÷ (1+0.12)2
99 ÷ (1+0.12)3

3. Using the calculator (NPV function)

4. Using the calculator (NPV function)

5. Using TVM to Make Business Decisions

6. Project Valuation & Decision Making
How do you properly answer the fundamental question?
Applications
Operating expenditures
Capital budgeting
Marketing campaigns
Considerations
Mutually exclusive projects (vs independent projects)
Capital rationing (vs unlimited funds)
Timing
Approval process
Ranking projects
Criteria
Key Criteria: NPV, IRR, PBP
Other criteria (PI, MIRR, etc.)

7. Net Present Value (NPV)
Present value of a stream of cash flows, minus the cost
If NPV > 0, project should be approved
If NPV < 0, project should be rejected
What does NPV = 0 imply about the IRR for a project?
Why is NPV a valid criterion?
What are the weaknesses of judging projects on NPV?

8. Using the calculator (NPV function)
Once you know the present value, how would you find NPV?
To find NPV easily, put the cost where CF0 goes in your calculator.
What if the initial investment were $1,100?

9. Using the calculator (NPV function)
Once you know the present value, how would you find NPV?
To find NPV easily, put the cost where CF0 goes in your calculator.
What if the initial investment were $250k?

10. Internal Rate of Return (IRR)
IRR = the “interest” implied by a stream of cash flows
If IRR > hurdle rate, project should be approved
If IRR < hurdle rate, project should be rejected
Why is IRR a valid criterion?
What are the weaknesses of judging projects on IRR?

11. Using the calculator (IRR function)

12. Using the calculator (IRR function)

13. Pay Back Period (PBP) How long will it take to recoup the cash outlay?
For example, a machine which costs $1,000k and saves $250k per year would pay for itself in 4 years (1,000 ÷ 250).
Therefore, the payback period would be 4 years.
What would the PBP be for this project?
What labels might be put on the cost?
Initial Investment, I0, CF0
Why is PBP a valid criterion?
What are the weaknesses of judging projects on PBP? 1 2 3 4
Cost: $380
100

15. Profitability Index (PI)
Puts projects into the same scale & provides a single, easy to read number
ΣPV ÷ Cost
If PI > 1, what does this imply about NPV?
If PI < 1, what does this imply about NPV?
Remember:
PI = ΣPV ÷ Cost
NPV = ΣPV – Cost