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    • 1. FARM MANAGEMENT <ul><li>WK 5: CAPITAL BUDGETS </li></ul><ul><li>(INVESTMENT ANALYSIS) </li></ul>MM WATERLOO
    • 2. FARM MTG CONCEPTS <ul><li>WK 1: INTRODUCTION </li></ul><ul><li>WK 2: ECONOMICS & FARM RECORDS </li></ul><ul><li>WK 3: BUDGETS </li></ul><ul><li>WK 4: WHOLE FARM BUDGETS </li></ul><ul><li>WK 5: CAPITAL BUDGETS </li></ul><ul><li>WK 6: MACHINERY MANAGEMENT </li></ul><ul><li>WK 7: LAND MANAGEMENT </li></ul><ul><li>WK 8: CREDIT MANAGEMENT </li></ul><ul><li>WK 9: HUMAN RESOURCE MANAGEMENT </li></ul><ul><li>WK 10: SUCCESSION MANAGEMENT </li></ul>
    • 3. TEXT BOOK READING ON CAPITAL BUDGETING <ul><li>FARM MANAGEMENT, 4th Ed </li></ul><ul><li>KAY & EDWARDS </li></ul><ul><li>CHAP 17: PG 309-332 </li></ul>WK 5: CAPITAL BUDGETS
    • 4. DISCUSSION POINTS <ul><li>I. INTRODUCTION </li></ul><ul><li>II. CAPITAL BUDGET STEPS </li></ul><ul><li>III. NON-TIME METHODS </li></ul><ul><li>A. PAYBACK </li></ul><ul><li>B. ACCT RATE OF RETURN </li></ul><ul><li>C. BOOK RATE OF RETURN </li></ul><ul><li>IV. SUMMARY </li></ul>WK 5: CAPITAL BUDGETS V. TIME METHOD A. TIME VALUE OF MONEY B. NET PRESENT VALUE METHOD C. BENEFIT COST RATIO D. INTERNAL RATE OF RETURN E. SUMMARY
    • 5. I. INTRODUCTION <ul><li>A. DEFINITION: ALLOCATION OF RESOURCES FOR MAJOR AND/OR LONG TERM PROJECTS </li></ul><ul><li>B. ASSUMPTIONS </li></ul><ul><li>1. UNLIMITED PROJECTS </li></ul><ul><li>2. LIMITED RESOURCES </li></ul>WK 5: CAPITAL BUDGETS
    • 6. IV. TIME VALUE OF MONEY <ul><li>YEAR 1: $100 * .10 * 1 YR = $110.00 </li></ul><ul><li>YEAR 2: $110 * .10 * 1YR = $121.00 </li></ul><ul><li>YEAR 3: $121 * .10 * 1 YR = $133.10 </li></ul><ul><li>LUMP SUM </li></ul><ul><li>INVESTMENT </li></ul><ul><li>$100 </li></ul>1st YR INTEREST 10% * 100 = $10 2nd YR INTEREST 10% *(100+10) = $11 3rd YR INTEREST 10% *(100+10+11)=12 A. FUTURE VALUE (COMPOUNDING) 1. ...OF A LUMP SUM FUT VAL = LUMP SUM*(1+i) N =$100 *(1+.10) 3 = $133.00
    • 7. USING CALCULATOR <ul><li>INSTRUCTION RESULT </li></ul>ENTER 1 1 PRESS + ENTER INTEREST AS DECIMAL .1 PRESS = 1.1 PRESS 2nd OR SHIFT PRESS X Y ENTER NUMBER OF YEARS 3 PRESS = 1.331 PRESS * ENTER LUMP SUM (PRESENT VALUE) 100 PRESS = Val of $100 3 yrs from now if 133.10 left to compound
    • 8. 2. …OF A YR END ANNUITY <ul><li>END 1st YR; $100 * (1+ .1) 2 = $121.00 END OF 3rd YR </li></ul><ul><li>END 2nd YR; $100 * (1 + .1) 1 = $110.00 END OF 3rd YR </li></ul><ul><li>END 3rd YR; $100 * (1 + .1) 0 = $ 100.00 END OF 3rd YR </li></ul><ul><li> $331.00 </li></ul><ul><li>$331 </li></ul>YR 1 INVEST $100 YR 2 INT $10 YR 3 INT $11 YR 2 INVEST $100 YR 3 INVEST $100 YR 3 INT $10 = FUT VAL = INV STREAM *(1 + i) N -1 i
    • 9. B. PRESENT VALUE (DISCOUNTING) 1. ... OF A FUTURE LUMP SUM <ul><li>PRES VAL (@10%) OF $ 100 RECEIVED 3 YR FROM NOW? </li></ul><ul><li>PRES VAL = FUTURE VALUE *[ 1/((1+.1) N )] </li></ul><ul><li>PRES VAL = 100 *[1/(1 + .1) 3 ] = $75.13 </li></ul><ul><li>PROOF: $75.13*(1 + .1) 3 = $99.998 </li></ul>$ ? LUMP SUM $82.60 $100 FUTURE VALUE IN 3 YRS $75.13 $90.01 $8.31 $7.47 $9.09
    • 10. 2. .... OF AN INVESTMENT STREAM <ul><li>END 1st YR; $100 * .909 = $90.90 (PRES VAL) </li></ul><ul><li>END 2nd YR; $100 * .826 = $82.60 (PRES VAL) </li></ul><ul><li>END 3rd YR; $100 * .751 = $75.10 (PRES VAL) </li></ul><ul><li>$248.60 </li></ul><ul><li>$248.60 IS MAX TO PAY FOR INVEST THAT PAYS $100/YR ANNUITY @ 10% INTEREST </li></ul><ul><li>PRES VAL = INV STRM*[1-(1 + i) -N ]/i </li></ul><ul><li>$75.13 </li></ul><ul><li>PRES </li></ul><ul><li>VAL </li></ul>$82.60 PRES VAL $90.91 PRES VAL $9.09 $7.47 $8.31 $9.09 $8.31 $9.09 $248.60 $75.13 + 82.60 + $90.91 PRESENT VALUE AT 10% TO GIVE $100 A YR FOR 3 YRS =
    • 11. IV. PRESENT VALUE METHODS <ul><li>A. NET PRESENT VAL & BENEFIT/COST </li></ul><ul><li>1. ADVANTAGES </li></ul><ul><li>a. CONSIDERS TIME VAL OF $ </li></ul><ul><li>b. FOCUS ON CASH FLOWS </li></ul><ul><li>2. DISADVANTAGES </li></ul><ul><li>a. MORE COMPLEX CALCULATIONS </li></ul><ul><li>b. ASSUMES REINVESTMENT AT </li></ul><ul><li>RATE OF RETURN </li></ul>
    • 12. B. NET PRESENT VAL CALCULATION <ul><li>INVESTMENT </li></ul><ul><li>CASH FLOW 1 </li></ul><ul><li>CASH FLOW 2 </li></ul><ul><li>CASH FLOW 3 </li></ul><ul><li>CASH FLOW 4 </li></ul><ul><li>CASH FLOW 5 </li></ul><ul><li>SALVAGE VAL </li></ul>LUMP $10,000 TABLE 2: 10% PRESENT VALUE -INVESTMENT NET PRESENT VALUE PRES VAL $9,315 0.909 0.826 0.751 0.683 $0 $0 $0 $0 $15,000 $0 $0 $0 $0 0.621 9,315 (685) -10,000
    • 13. B. NET PRESENT VAL CALCULATION <ul><li>INVESTMENT </li></ul><ul><li>CASH FLOW 1 </li></ul><ul><li>CASH FLOW 2 </li></ul><ul><li>CASH FLOW 3 </li></ul><ul><li>CASH FLOW 4 </li></ul><ul><li>CASH FLOW 5 </li></ul><ul><li>SALVAGE VAL </li></ul>LUMP $10,000 $0 $0 $0 $0 $15,000 PRESENT VALUE -INVESTMENT NET PRESENT VALUE CALCULATOR ENTER 1, PRESS + ENTER INT AS..XX PRESS = PRESS 2nd/SHIFT PRESS XY ENT YRS, PRESS =
    • 14. <ul><li>INVESTMENT </li></ul><ul><li>CASH FLOW 1 </li></ul><ul><li>CASH FLOW 2 </li></ul><ul><li>CASH FLOW 3 </li></ul><ul><li>CASH FLOW 4 </li></ul><ul><li>CASH FLOW 5 </li></ul><ul><li>SALVAGE VAL </li></ul>EQUAL $48,000 $10,000 $10,000 $10,000 $10,000 $10,000 TABLE 2: 10% PRESENT VALUE -INVESTMENT NET PRESENT VALUE PRES VAL 9,090 8,260 7,510 6,830 6,210 37900 $37,900 -$48,000 ($10,100) 0.621 [3.790] 0.683 0.751 0.826 0.909
    • 15. <ul><li>INVESTMENT </li></ul><ul><li>CASH FLOW 1 </li></ul><ul><li>CASH FLOW 2 </li></ul><ul><li>CASH FLOW 3 </li></ul><ul><li>CASH FLOW 4 </li></ul><ul><li>CASH FLOW 5 </li></ul><ul><li>SALVAGE VAL </li></ul>UNEQUAL $4,000 $2,000 $2,000 $3,000 TABLE 2: 10% 0.909 0.826 0.751 PRESENT VALUE -INVESTMENT NET PRESENT VALUE PRES VAL 1,818 1,652 2,253 5,723 $ 5,723 -$4,000 $1,723
    • 16. B. BENEFIT- COST CALCULATION <ul><li>INVESTMENT </li></ul><ul><li>CASH FLOW 1 </li></ul><ul><li>CASH FLOW 2 </li></ul><ul><li>CASH FLOW 3 </li></ul><ul><li>CASH FLOW 4 </li></ul><ul><li>CASH FLOW 5 </li></ul><ul><li>SALVAGE VAL </li></ul>LUMP $10,000 $0 $0 $0 $0 $15,000 EQUAL $48,000 $10,000 $10.000 $10,000 $10,000 $10,000 PRESENT VALUE INVESTMENT BENEFIT/COST = UNEQUAL $4,000 $2,000 $2,000 $3,000 9,315 10,000 37,900 48,000 5,723 4,000 1.43 .790 .932
    • 17. <ul><li>1. ADVANTAGES </li></ul><ul><li>a. CONSIDERS ALL CASH FLOWS </li></ul><ul><li>b. PROVIDES BASE FOR COMPARISON </li></ul><ul><li>2. DISADVANTAGE </li></ul><ul><li>a. MOST COMPLEX </li></ul><ul><li>b. ASSUMES REINVESTMENT AT </li></ul><ul><li>INTERNAL RATE OF RETURN </li></ul>B. INTERNAL RATE OF RETURN
    • 18. 3. INTERNAL RATE OF RET <ul><li>1. USE PAYBACK PERIOD </li></ul><ul><li>2. FIND APPROP ROW IN TABLE1 </li></ul><ul><li>3. GO ACROSS TO FIND PAYBACK </li></ul><ul><li>4. READ UP TO FIND % RET </li></ul>LUMP 4.66 5 YR X.XX - XX.X 3 - 4 % EQUAL 4.8 5 YR X.XX - X.XX 3 - 4% UNEQUAL 2.0 5 YR X.XX - X.XX 3- 4%
    • 19. TIME SUMMARY <ul><li>NET PRES VALUE </li></ul><ul><li>BENEFIT COST </li></ul><ul><li>INTERNAL </li></ul><ul><li>RATE </li></ul>LUMP EQUAL UNEQUAL $-685 $-10,100 $1,723 .932 .790 1.43 XX% % % WK 5: CAPITAL BUDGETS
    • 20. SUMMARY <ul><li>1. CAPITAL BUDGETING LOOKS AT THE PROFITABILITY OF LG. INVESTMENTS </li></ul><ul><li>2. RESULTS OF “NON-TIME” METHODS ( PAYBACK, ACCT RATE OF RET, & BOOK RATE OF RETURN) CAN NOT BE COMPARED TO BANK RATES. </li></ul><ul><li>3.RESULTS OF “TIME” METHODS (NET PRESENT VAL, BENEFIT-COST, & INTERNAL RATE OF RET) CAN BE COMPARED TO BANK RATES </li></ul>WK 5: CAPITAL BUDGETS
    • 21. ASSOCIATED LAB ACTIVITIES <ul><li>CALCULATION OF INVESTMENT MEASURES </li></ul><ul><li>-- PAYBACK </li></ul><ul><li>-- ACCT RATE OF RETURN </li></ul><ul><li>-- BOOK RATE OF RETURN </li></ul><ul><li>-- NET PRESENT VALUE </li></ul><ul><li>-- BENEFIT/COST </li></ul><ul><li>-- INTERNAL RATE OF RET </li></ul>WK 5: CAPITAL BUDGETS
    • 22. SELF TEST <ul><li>PRES VAL / INVESTMENT </li></ul><ul><li>BENEFIT- COST </li></ul>SIMPLEST METHOD BUDGET FOR BIG ITEMS QUANTATIVE BASIS NON-TIME METHOD W/O SALV COMPARED TO BANK RATES IMAGE, PRETIGE NON-TIME METHOD WITH SALV TIME TO RECOVER INVESTMENT PRES VAL - INVESTMENT PAYBACK CAPITAL “ WILL IT PAY” ACCT RATE TIME METHODS QUALITATIVE BASIS BOOK RATE PAYBACK NET PRES VAL
    • 23. EVALUATION <ul><li>YOUR UNDERSTANDING OF THESE CAPITAL BUDGET CONCEPTS WILL EVALUATED ON THE MIDTERM TO BE GIVEN THE FIFTH FRIDAY OF THE QUARTER (THIS WEEK!!!!!!!!) </li></ul>WK 5: CAPITAL BUDGETS
    • 24. MIDTERM THIS FRIDAY !!!!! <ul><li>PART 1: OBJECTIVE QUESTIONS (T/F, MC, ETC) </li></ul><ul><li>10 PTS: WK 1- INTRODUCTION </li></ul><ul><li>10 PTS: WK 2- ECONOMICS & RECORDS </li></ul><ul><li>10 PTS: WK 3- BUDGETS (CASH, ENT, ETC) </li></ul><ul><li>10 PTS: WK 4- LINEAR PROGRAMMING </li></ul><ul><li>10 PTS: WK 5- CAPITAL BUDGETS </li></ul><ul><li>PART II. PROBLEMS </li></ul><ul><li>20 PTS: ECONOMICS 5 PTS: BUDGETS </li></ul><ul><li>18 PTS: LINEAR PROG 9 PTS: INVESTMENT </li></ul>
    • 25. NEXT TOPIC <ul><li>TIMELINESS </li></ul>INTERNATIONAL HARVERSTER W4
    • 26. IV. TIME VALUE OF MONEY V. TIME METHODS A. NET PRESENT VALUE B. BENEFIT COST C. INTERNAL RATE OF RETURN

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