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Corporate finance

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  • Milk automat machines in Karvina
  • How much is your salary? (for British), How old are you? (for Chineese), do you a believer? (for everybody)
  • Transcript

    • 1. CORPORATE FINANCE Ekrem Tufan etufan@yahoo.com 2010-2011 http://etufan.wordpress.com Canakkale Onsekiz Mart University School of Tourism and Hotel Management
    • 2. What will we learn? Week 1: Introduction to corporate finance - What is the finance, corporate finance? -Summary history of managerial finance -The financial manager’s responsibility -The goals of the corporation
    • 3. What will we learn? Week 2: An overview of managerial finance Week 3: Financial forecasting (Demand and sales forecast) • Questionnaire method • Forecast by using economic indicators relation • International comparison
    • 4. What will we learn Week 4: Financial forecasting (Demand and sales forecast) continuation… • Income elasticity of demand method • Graphic method • Least squares method • Correlation and regression methods (Please check on your statistics notes) Week 5: Market share calculation Week 6: Profit planning • Break Even Analysis • Operating Leverage • Financial Leverage
    • 5. What will we learn Week 7: Profit planning (Continuation) • Break Even Analysis • Operating Leverage • Financial Leverage Week 8: Working capital management Week 9: Capital budgeting • Payback Period • Net Present Value • Internal Rate of Return • Sensitivity Analysis Week 10:Capital budgeting (Continuation)
    • 6. What will we learn • Week 11: Student presentations • Week 12: Student presentations
    • 7. What are we going to acquire? • Learning forecasting of sales (demand). • If you know your future sales, you can make profit planning and know how much fund do you need for working and fixed capital. • Learning how to evaluate and choose the best investment opportunity by applying some methods.
    • 8. What kind of resources can we use when we doing research? 1. All finance books 2. All articles about finance 3. www.ssrn.com 4. Essentials of Managerial Finance, J. Fred Weston and Eugene Brigham, Harcourt Brace&Company International Edition, 1992 5. Kuhlman Bruce, David W. Wiley and H. Kent Baker, Business Fundamentals, Schweser Institute certificate Program, Publisher: Dearborn Trade, A Kaplan Professional Company, ISBN: 9781419528965 (Electronic book), 2005.
    • 9. What kind of resources can we use when we doing research? 6. http://en.wikipedia.org/wiki/Demand_foreca sting 7. http://www.angelfire.com/mn3/apse/entles 3.htm 8. Brealey Richard A., Stewart C. Myers and Franklin Allen, Principles of Corporate Finance, The McGraw Hill Companies International edition 2008, ISBN: 978-007- 126327-6
    • 10. What kind of resources can we use when we doing research? 9. http://etufan.wordpress.com 10.http://en.wikipedia.org/wiki/Demand_foreca sting 11.http://en.wikipedia.org/wiki/Questionnaire_ construction
    • 11. What is the finance? • Money • Stock exchange • Banks • What else? • How about the companies? • Balance sheet
    • 12. What is the finance? • To achieve the goals of company; 1. Finding funds from the most suitable sources 2. Using them effectively and 3. Control the results…
    • 13. An Overview of Managerial Finance • A Short History of Managerial Finance • 1930s: Liabilities and equity http://www.youtube.com/watch? v=TpfY8kh5lUw • 1940 and 1950s: Assets, quantitative methods, discounted cash flow methods http://www.youtube.com/watch? v=5KPCl9wh1G4 • 1960 and 1970s: Optimization of assets and liabilities and equity, statistical methods • 1980s: Globalization, interest rate and exchange risk http://www.youtube.com/watch?v=4pjSlIkNxXg • 1990-2000s to today: More risk, more computer, new financial instruments and methods
    • 14. An Overview of Managerial Finance
    • 15. An Overview of Managerial Finance • The Financial Manager’s Responsibility • Forecasting and planning • Major investment and control • Coordination and control • Dealing with the financial markets
    • 16. An Overview of Managerial Finance • The goals of the corporation • Managerial incentives to maximize shareholder wealth • Social responsibility • Stock price maximization and social welfare
    • 17. Managerial incentives to maximize shareholder wealth •Stockholders •Make the highest money from the company •Do not want to share theirs company with others. •Managers •Having autonomy •Protect themselves from a hostile takeover or a proxy fightHostile takeover.doc Example •Try to maximize stock prices in reasonable level
    • 18. Social responsibility • Ethical responsibility to provide a safe working environment • To avoid polluting water and air • Produce safe products • But social responsibility has a cost • If the other firms in its industry do not follow suit, their prices and costs will be lower • Most investors do not like to buy socially oriented companies shares.
    • 19. Stock price maximization and social welfare What requires stock price maximization? 1. Efficient, low-cost plants that produce high- quality goods and services at the lowest possible cost 2. Development of products that consumers want and need, so the profit motive leads to new technology, to new products, and to new jobs Example Example 2
    • 20. An Overview of Managerial Finance • The Financial Manager’s Responsibility •Forecasting and planning • Major investment and control • Coordination and control • Dealing with the financial markets
    • 21. Financial forecasting
    • 22. Some Financial Forecasting Methods • Questionnaire method • Forecast by using economic indicators relation • International comparison • Income elasticity of demand method • Graphic method • Least squares method
    • 23. Financial forecasting: Questionnaire Simple things: • Quantitative marketing researches and social sciences • Especially, if it is known specific target consumer • By phone, by email, web, go to houses and malls…
    • 24. Take into consider for questionnaire 1. Determining research aims, example size, duration, human resources, permissions, and privacy before applying questionnaire, 2. Determining natural answers, 3. Questionnaires should be directly related with research’s aims, 4. Applying questionnaire to right participants is very important, 5. Determining questionnaire’s type…
    • 25. Take into consider for questionnaire • Questions and answers should be neutral, • Ranking and grouping of questions’ should be right, • Questions’ should be basic and non-technical, • No double meaning and negative sentences, • Every question should ask just one subject, • Put “other” option, • Questions’ should be daily communication sentences,
    • 26. Take into consider for questionnaire • Do not ask private questions, • Carefully use colours, graphics or pictures, • Give numbers to your questions.
    • 27. An example (This example has been derived from Güvemli Oktay, Yatırım Projelerinin Düzenlenmesi, Değerlendirilmesi ve İzlenmesi, Atlas Kitabevi Yayınları, İstanbul:2008, pp.89-90, ISBN 9789756574065) We would like to search demand of honey consumption of Karvina. We chose an area as example which represents whole Karvina. In this area, there are 200 houses. So we prepared a basic questionnaire and asked questions’ below: 1.Does your family consume honey? 2.If so, how much do you consume per month? 3.How many people live in your family?
    • 28. An example (Continuation…) Answers: 1.Yes we consume (150 family), No (50 family) 2.500 gram per month 3.4 people If we assume that Karvina’s population is 70.000, the demand could be calculated as:
    • 29. An example (Continuation…) Family count in Karvina: 70.000/4=17.500 Family Percentage of families who are bought honey= (150 family/200 Family)x100=75% Count of families who are bought honey= 17.500 Family x 75%= 13.125 Family Yearly consumption per family: 500 Gramx12 month=6.000 Gram=6 kg Yearly consumption= 13.125 family x 6 Kg =78.750 Kg.
    • 30. An example (Continuation…) If Karvina’s population growth rate is +0.41%; We can predict honey consumption: Year Family count Honey buy Yearly consumption family count 2011 17.571 13.178* 79.068** 2012 17.643 13.232 79.392 2013 17.715 13.286 79.716 2014 17.787 13.340 80.040 *(17.571x75%), **(13.178x6kg)
    • 31. Financial forecasting: Economic indicators relation Finding data which correlated each other for searched sector/subject. Examp: Weather Crop Bread price Demand estimation using correlated data.
    • 32. Plasterboard Demand Example (Source: Güvemli Oktay, Yatırım Projelerinin Düzenlenmesi, Değerlendirilmesi ve İzlenmesi, Atlas Kitabevi Yayınları, İstanbul:2008, pp.90, ISBN 9789756574065)
    • 33. Example (Continuation…) Plasterboard or also called gypsum board are panels made of gypsum plaster pressed between two thick sheets of paper, the panels are used to make interior walls and ceilings. (http://en.wikipedia.org/wiki/Drywall). As Sweet Home Company, we would like to produce and enter plasterboard market in Karvina. Lets calculate demand with using house counts and floor space!
    • 34. Example (Continuation…) • Internal walls two faces are averagely equal 250 m2 for 100 m2 house while external walls faces are averagely equal 130 m2 . There are 20% gaps these walls for windows and doors. • Lets calculate how much wall surface for plasterboard do we have for a 100 m2 houses?
    • 35. Example (Continuation…) • Internal walls two face surface is equal (250 m2 x 80%) = 200 m2 • External walls two face surface is equal (130 m2 x 80%) = 104 m2 • Whole surface which it can be applied plasterboard is equal (200 + 104 ) 304 m2 . We assume that demand for buildings could be 5% for first year and later 7%, 10%, 12% respectively.
    • 36. Example (Continuation…) It is being predicted new buildings counts which will be built in four years and theirs’ surface is: Years Buildings Surface (m2) 1 160.000 16.000.000 2 175.000 17.500.000 3 190.000 19.000.000 4 210.000 21.000.000
    • 37. Example (Continuation…) Plasterboard demand: Years Building Estimated plasterboard Plasterboard Counts demanded buildings demand 1 160.000 x (5%) 8.000 *2.432.000 2 175.000 x (7%) 12.250 3.724.000 3 190.000 x (10%) 19.000 5.776.000 4 210.000 x(12%) 25.200 7.660.800 * 1. year demand = 8.000 x 304 m2 = 2.432.000 m2
    • 38. International comparison This method based on comparing two countries Gross Domestic Product (GDP) per capita and demands which one of them is developed while another developing and assumed that developing country’s demand is going to reach to developed country’s demand in the future . Step 1: Determining developed country’s demand for a specific good and GDP per capita Step 2: Assuming that developing country’s demand will be equall developed country’s demand in the future.
    • 39. International comparison (Example) Resource: This example has been derived from Güvemli, pp.92. In France, GDP per capita is 30.000€ and orange juice consumption is 15 liter. In Czech Republic GDP per capita is 10.000 € and orange juice consumption is 3 liter. The population is 11.000.000.
    • 40. Example (Continuation…) Years GDP per capita in Czech Consumption per capita 1 10.000 3 2 15.000 4,5 3 17.000 7,5 4 18.000 9,3 5 22.000 11,2 6 28.000 13,1 7 30.000 15,0 * 7th year data is equal to France current data.
    • 41. Example (Continuation…) Years Population of Czech (000) Tot. Juice consumption 0 11.000 x 3 liter = 33.000 (Current) 1 11.500 x 3,6 = 41.400 2 11.800 x 4,5 = 53.100 3 12.000 x 7,5 = 90.000 4 12.400 x 9,3 = 115.320 5 12.900 x 11,2 = 144.480 6 13.000 x 13,1 = 170.300 7 13.000 x 15,0 = 195.000
    • 42. Income elasticity of demand Example: (Güvemli pp.95) Rate of increment of GDP per capita = 3,5% Coefficient of income elasticity of product = 2 Rate of increment of product’s yearly per capita demand = 7% (3,5% x 2) Note: Income elasticity is calculated by dividing rate of increment of demand to rate of increment income.
    • 43. Income elasticity of demand Example 1: Past periods 2007 2008 2009 Sale of product “A” (Unit) 150.000 180.000 220.000 Yearly rate of increment 20% 22% Average rate of increment ((0,20+0,22)/2) = 21% GDP rate of increment 3,5% 4% 3,6% GDP average rate of increment = (0,035 + 0,04 + 0,036) / 3 = 3,7% Coefficient of income elasticity (21%/3,7%) = 5,6
    • 44. Income elasticity of demand Demand of product “A”? Next periods 2010 2011 2012 Averg. Predicted GDP rate of increment ((4% + 4,2% + 4,4%)/3)= 4,2% Coefficient of income elasticity = 5,6 Yearly rate of increment= (4,2% x 5,6) = 23,5% Demand of product “A” (2010 period) = 220.000 x 123,5% = 271.700 (2011 period) = 271.700 x 123,5% = 335.550 (2012 period) = 335.550 x 123,5% = 414.404
    • 45. It is your turn! Question: Dogtas Company is a Turkish company which produces home inner products such as furniture. Dogtas company sold 80.000 furniture in 2007, while 125.000 in 2008 and 100.000 in 2009 respectively. In same period GDP rate of increment was 7%, 9% and 5% respectively. Because World economic crisis, it is being expected GDP rate of increment will be -2% in 2010 while 3% in 2011 and 5% in 2012. So, please calculate Dogtas Company’s furniture demands in 2010, 2011 and 2012.
    • 46. Graphic method In this method, demand of product and dates are being located on a graphic. Then taking account the numbers density and draw a line. This method is very basic but not reliable.
    • 47. Graphic method (Example) Date (2009) Demand January 2500 February 2800 March 3050 April 3476 May 3899 June 1257 July 1289 August 3456 September 4900 October 5600 November 7988 December 3678 January 8899 February 7654 March 7889 April 9900 May 6754 June 5678 July 6754 August 7654 September 9876 October 7654 November 7865 December 8888
    • 48. Least squares method We can use Excel to estimate the demand of our product(s) with applying least squares method.
    • 49. Least squares method Step 1: Open an Excel page and click fx (functions) and chose “Statistics” Step 2: Chose “forecast”. Then you will see three spaces. Step 3: For first space chose estimated year (In our examp. 10), for second space chose demand numbers and for third space chose years (In our example from 1 to 9) Step 4: Click to Enter and get the result. Example Years Demand 1 1250 2 1578 3 3234 4 7500 5 3456 6 2200 7 4578 8 6543 9 2134 10 4926
    • 50. How to calculate market share? There are two ways to calculate market share: I. Percentage of sale units: Company’s sale units/Total sale units in the market II. Percentage of income: Total income of the company / Total income of the sector which the company belongs
    • 51. How to calculate market share? Example: Our company produces cheese in Çanakkale. In 2009 it has produced 70 ton cheese in the city and sold them at 70.000 Euro. In same period our company produced 7 ton cheese and sold it 12.000 Euro. So; Our market share as a unit is: (7 Ton / 70 Ton)x100= 10% Our market share as a sale: (12.000 Euro/70.000 Euro)x100= 17,14%
    • 52. Profit planning • Break Even Analysis • Operating Leverage • Financial Leverage
    • 53. Why should we plan our profit?
    • 54. Financial managers use profit planning for; • Determine at least how much products should be produced to get profit with using sale and cost information, • Which products should be produced and how much? • Determine the price of the product
    • 55. What kind of data do we need?
    • 56. Data • Unit sale price of the product • Sale volume of the product • Sale composition of the products • Unit variable cost • Total fixed costs
    • 57. Assumptions of profit planning • Costs are divided into two such as fixed and variable but there is one more which is half variable costs • There is only one price and stable • Input prices are fixed • At the end of the financial term, there is no inventory
    • 58. Profit planning • Break Even Analysis • Operating Leverage • Financial Leverage
    • 59. When should we use Break Even Analysis?
    • 60. We can use Break Even Analysis… • To decide producing a new product and it’s sale volume to get profit • To decide company’s to grow or non-grow situation • To decide to realise modernisation and automation investments • To measure effect of variation of price, fixed and variable costs on profit It can be applied both graphic and mathematics methods...
    • 61. Graphic Method Amount of production Income-cost Break even point loss Profit Total Income Total costs
    • 62. Continuation... Loss Profit Break Even Point Income-Cost Amount of production Total Income Total costs Break Even Point Loss
    • 63. Mathematical Method Production level in Break Even Point: Q=F/P-V Sale level in Break Even Point: S=F/1-(V/P) Q: Production level in Break Even Point F: Fixed costs P: Unit price V: Unit variable costs
    • 64. Example (1) for Break Even Analysis Microsoft Company’s sale is 5.000.000 Euro when production is 20.000 unit, variable costs are 3.000.000 Euro and fixed costs are 1.000.000 Euro. In this case, what is the production level in break even point? Unit price: 5.000.000/20.000=250 Euro Unit variable cost: 3.000.000/20.000=150 Euro Q=1.000.000/250-150 = 10.000 Unit
    • 65. Example (II) If it is being used same data with first example sale level in break even point=? S=F/1-(V/P) =1.000.000/1-(150/250) =2.500.000 Euro
    • 66. Different approach to calculate break even point: Additive margin Additive margin = Unit price-Unit variable costs Amount of production in break even point= Total fixed costs/Unit additive margin Additive rate=(Unit price-Unit variable costs) / Unit price Amount of sale in break even point= Total fixed costs/Additive rate
    • 67. Example III Amount of production in break even point= Total fixed costs/Unit additive margin Unit additive margin = 250-150 = 100 Amount of production in break even point = 1.000.000/100 = 10.000 unit
    • 68. Continuation…. Additive rate=Unit price-Unit variable cost/Unit price Sales in break even point= Total fixed costs/additive rate = 1.000.000/(250-150/250) = 2.500.000 Euro
    • 69. Break even point and target profit Amount of production in break even point which is being taken consider target profit= (Fixed costs + EBIT)/(Unit price-Unit variable cost) The company is targeting 2.000.000 Euro profit. So, what is the amount of production in break even point =(1.000.000+2.000.000)/(250-150) Additive rate = 30.000 Unit How about break event point in sale?
    • 70. Profit planning • Break Even Analysis • Operating Leverage • Financial Leverage
    • 71. When should we use Operating Leverage?
    • 72. We can use operating leverage… • To search how much fixed and variable costs can be accepted by using relationship between them • To estimate extra productions effect on profit when production exceeds a certain level • To decide if a company based on labour force or capital
    • 73. Operating Leverage Formulas SALES SALES EBIT EBIT OP or yvariabilitProfit (yvariabilitSales OP ∆ ∆ = = (%) %)
    • 74. Operating Leverage Formulas EBIT CostsVariableSales OL − =
    • 75. Example Student Agency Company’s variable costs are 3.000.000 € at 5.000.000 € sales level. EBIT is 1.000.000 €. If we assume that sales can be increased 10%, EBIT will be 1.200.000 €. So, This means, profit will increase 2 € if sales increase 1 € at 5.000.000 € sales level. 2 000.000.5/)000.000.5000.500.5( 000.000.1/)000.000.1000.200.1( = − − =OP
    • 76. Example EBIT CostsVariableSales OL − = 2 000.000.1 000.000.3000.000.5 = − =OL
    • 77. Lets check the result… Sales Variable costs Fixed costs Total Costs EBIT Current situation 5.000.000 € 3.000.000 € 1.000.000 € 4.000.000 € 1.000.000 € New situation 5.500.000 € 3.300.000 € 1.000.000 € 4.300.000 € 1.200.000 € % 10 10 0 7.5 20 2 %10 %20 (%) %) === yvariabilitProfit (yvariabilitSales OP
    • 78. Profit planning • Break Even Analysis • Operating Leverage • Financial Leverage
    • 79. When should we use Financial Leverage?
    • 80. We can use financial leverage… To search a company’s debts effect on it’s profit.
    • 81. Financial leverage formulas costInreterestC CEBIT EBIT FL = − = EBIT EBIT shareperprofit shareperprofit FL increaseProfit shareperincreaseProfit FL ∆ ∆ = =
    • 82. Example Student Agency Company’s capital is 20.000.000 €, total debts are 10.000.000 €. Debts are 8% interest rate bank loans. EBIT is 15.000.000 €. Please calculate financial leverage of the company and make comments on the result.
    • 83. Example Interest cost = 10.000.000 € x 8% = 800.000 € If other company’s financial leverage is 1.5 this means our company has less risk. If the company use more debt does it good for it? We are in an economic crises. So, what do you think our company’s situation if we compare other one in our example? costInreterestC CEBIT EBIT FL = = − = − = 05.1 000.800000.000.15 000.000.15
    • 84. WORKING CAPITAL MANAGEMENT
    • 85. Working capital terminology Working capital (gross working capital): Current assets Net working capital: Current assets – current liabilities
    • 86. Working capital: Peddler example
    • 87. The conversion cycle Real Time Computer Corporation (RTC), which in early 1992 introduced a new super minicomputer that can perform 15 million instructions per second and that will sell for $250.000. The effects of this new product on RTC’s working capital position were analyzed in terms of the following five steps:
    • 88. Continuation… 1. RTC will order and receive the materials it needs to produce the 100 computers that are expected to be sold. Because RTC and most other firms purchase materials on credit, this transaction will create an account payable. However, the purchase will have no immediate cash flow effect.
    • 89. Continuation… 2. Labor will be used to convert the materials into finished computers. However, wages will not be fully paid at the time the work is done, so accrued wages will build up. 3. The finished computers will be sold but on credit, so sales will create receivables, not immediate cash inflows.
    • 90. Continuation… 4. At some point during the cycle, RTC must pay off its accounts payable and accrued wages. Because these payments will be made before RTC has collected cash from its receivables, a net cash outflow will occur, and this outflow must be financed. 5. The cycle will be completed when RTC’s receivables have been collected. At that time, the company will be in a position to pay off the credit that was used to finance production, and it can then repat the cycle.
    • 91. Cash conversion cycle model Inventory conversion period (ICP): It is the average length of time required to convert materials into finished goods then sell those goods. Inventory conversion period= Inventory / Sales per day For example: If average inventories are $2 million and sales are $10 million; ICP=$2.000.000/($10.000.000/360) = 72 days
    • 92. Continuation… Receivables collection period (RCP): It is the average length of time required to convert the firm’s receivables into cash, that is, to collect cash following a sale. RCP= Receivables / (sales/360) If receivables are $666,667 and sales $10 million, RCP= $666,667 / ($10,000,000/360)= 24 Days
    • 93. Continuation… Payables deferral period (PDP): It is the average length of the time between the purchase of materials and labour and the payment of cash for them. PDP= Payables/ Credit purchases per day = Payables/ (cost of goods sold /360) If the firm on average has 30 days to pay for labour and materials, if its cost of goods sold are $8 million per year, and if accounts payable average $666,667; PDP= $666,667 / ($8,000,000/360) = 30 days
    • 94. Continuation… Cash conversion cycle (CCC): It nets out the periods just defined and which therefore equals the length of time between the firm’s actual cash expenditures to pay for productive resources (labour and materials) and its own cash receipts from the sale of products. CCP= Inventory conversion period + receivables collection period - payables deferral period
    • 95. Continuation… CCP= Inventory conversion period + receivables collection period - payables deferral period CCP= 72 days + 24 days – 30 days CCP= 66 days
    • 96. Result With calculating and finding 66 days, RTC knows when it starts producing a computer that it will have to finance the manufacturing costs for a 66 day period. The firm’s goal should be to shorten its cash conversion cycle as much as possible without hurting operations.
    • 97. It is your turn! Dardanel A.Ş. Produces frozen and canned food such as sea fishes, octopus and mussel. The company will produce new product namely blue fish which lives only in Istanbul Bosporus and Canada. So the product is very valuable and expensive. It has also market in Europe. A canned food be produced in 20 minutes and work hours are 8 hours per day. Marketing department says 90% of the production will be sold .The price will be 10 Euros per canned food. Average inventories are 8.000 Euro. (330 working days assumed but year 360 days.
    • 98. Continuation… Other things related with sales: • Labour get salary 30 days after the work • Payments for raw material are done 45 days later • 80% of sales are done cash while 20% of sales are credit. • Cost of goods are sold is 28.800 Euro • Accounts payable is 12.200 Euro Please calculate effects of this new product on Dardanel Company’s working capital position:
    • 99. CAPITAL BUDGETING (Strategic Long term Investment Decision)
    • 100. Capital budgeting (Strategic Long-Term Investment Decisions) • Generating ideas for capital projects • Who creates the capital budgeting projects? • Do we need to be an entrepreneur? • Two questions for testing being entrepreneur (CV and address book)
    • 101. Strategic Long-Term Investment Decisions • Project classifications 1. Replacement: Maintenance of business 2. Replacement: Cost reduction 3. Expansion of existing products or markets 4. Expansion into new products or markets 5. Safety and/or environmental projects 6. Other
    • 102. Project classifications • Replacement: Maintenance of business • One category consists of expenditures to replace worn-out or damaged equipment used in the production of profitable products. • Should we continue to produce these products or services? • Should we continue to use our existing production processes?
    • 103. Project classifications • Replacement: Cost reduction • This category includes expenditures to replace serviceable but obsolete equipment. • The purpose here is to lower the costs of labour, materials, or other inputs such as electricity.
    • 104. Project classifications • Expansion of existing products or markets • Expenditures to increase output of existing products, or to expand outlets or distribution facilities in markets now being served are included here.
    • 105. Project classifications • Expansion into new products or markets • These are expenditures necessary to produce a new product or to expand into a geographic area not currently being served.
    • 106. Project classifications • Safety and/or environmental projects • Expenditures necessary to comply with government orders, labour agreements, or insurance policy terms fall into this category.
    • 107. Project classifications • Other project investments • This catch all includes office buildings, parking lots, executive aircraft, and so on.
    • 108. Strategic Long-Term Investment Decisions • Similarities between capital budgeting evaluation techniques 1. Project cost 2. Expected cash flows estimation 3. Estimation of project riskiness 4. Cost of capital decision 5. Measurement of present value of cash inflows 6. Present value of the expected cash inflows and required outlay
    • 109. Capital Budgeting Evaluation Techniques 1. Payback Period 2. Net Present Value (NPV) 3. Internal Rate of Return (IRR) 4. Sensitivity Analysis
    • 110. Capital Budgeting Evaluation Techniques • Payback period • Project S : Net Cash Flow Cumulative NCF
    • 111. Payback period • Project (S) Uncovered cost at start of year Payback=Year before full recovery + Cash flow during year 100 Payback Period (S)= 2 + = 2,333 Years 300
    • 112. Capital Budgeting Evaluation Techniques • Payback period • Project L : • Net Cash Flow • Cumulative NCF
    • 113. Payback period • Project (L) 200 Payback Period (L)= 3 + = 3,333 Years 600
    • 114. Net Present Value (NPV) • To implement this method, it should be proceeded as follows: • Find the present value of investment and its future cash flows with discounting at the project’s cost of capital • Sum discounted investment and cash flows • If the NPV is positive then we accept the project. If we have to choose a project among the alternate projects, we should take into consider the highest NPV
    • 115. Net Present Value (NPV) n n k CF k CF k CF CFNPV )1( .............. )1()1( 2 2 1 1 0 + ++ + + + += ∑= + = n t t t k CF 0 )1(
    • 116. Capital Budgeting Evaluation Techniques • Internal rate of return (IRR) • The IRR is defined as that discount rate which equates the present value of a project’s expected cash inflows to the present value of its expected costs.
    • 117. Internal rate of return (IRR) 0 )1( .............. )1()1( 2 2 1 1 0 = + ++ + + + + n n IRR CF IRR CF IRR CF CF 0 )1(0 = + =∑= n t t t IRR CF
    • 118. Example of NPV, IRR and Sensitivity • Small Scale Flower Cultivation Project in India • This project has written by Weitz Center (Israel) experts for an area in India. • The project covers an area about one acre. The aim is producing and selling flowers. Project’s cost will be covered by a bank loan. All costs and sale data have been collected and realised that target sales could be achieved. Cost benefit analysis Flower.xls
    • 119. Thanks for your patience…

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