1. Business Finance BA303 Michael Dimond

2. Michael Dimond School of Business Administration If you require a 12% annual return, what would you pay for… …$90 to be delivered in 1 year? ($80.3571) …$95 to be delivered in 2 years? ($75.7334) …$99 to be delivered in 3 years? ($70.4662) …all of the above? By adding together the present values, you find the value of all the cash flows in the stream. Discounting unequal cash flows 0123 ? 99 i = 12% 99 ÷ (1+0.12) 3 95 95 ÷ (1+0.12) 2 90 90 ÷ (1+0.12) 1 80.3571 75.7334 + 70.4662 226.5567 There’s an easier way… kind of.

3. Michael Dimond School of Business Administration Using the calculator (NPV function) NPV(12,0,{100,200,300,400,500})

4. Michael Dimond School of Business Administration Using the calculator (NPV function) NPV(9,0,{100,90,80,25},{1,1,1,6})

5. Michael Dimond School of Business Administration Using TVM to Make Business Decisions

6. Michael Dimond School of Business Administration 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. Michael Dimond School of Business Administration 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, I 0, CF 0 Why is PBP a valid criterion? What are the weaknesses of judging projects on PBP? 01234 Cost: $380 100

8. Michael Dimond School of Business Administration 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?

9. Michael Dimond School of Business Administration Using the calculator (IRR function) IRR(-1100,{100,200,300,400,500})

10. Michael Dimond School of Business Administration Using the calculator (IRR function) IRR(-250,{10090,80,25},{1,1,1,6})

11. Michael Dimond School of Business Administration 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?

12. Michael Dimond School of Business Administration Using the calculator (NPV function) Once you know the present value, how would you find NPV? To find NPV easily, put the cost where CF 0 goes in your calculator. What if the initial investment were $1,100?

13. Michael Dimond School of Business Administration Using the calculator (NPV function) Once you know the present value, how would you find NPV? To find NPV easily, put the cost where CF 0 goes in your calculator. What if the initial investment were $250k?

14. Michael Dimond School of Business Administration Profitability Index (PI) Puts projects into the same scale & provides a single, easy to read number Σ PV ÷ Cost If PI > 1, what does this imply about NPV? If PI < 1, what does this imply about NPV? Remember: PI = Σ PV ÷ Cost NPV = Σ PV – Cost

15. Michael Dimond School of Business Administration Exam #2 Tuesday, 2/19/13