Financial  Management    Investment  Appraisal
Upcoming SlideShare
Loading in...5
×
 

Like this? Share it with your network

Share

Financial Management Investment Appraisal

on

  • 5,592 views

ACCA 2.4

ACCA 2.4
Investment Appraisels Part 1

Statistics

Views

Total Views
5,592
Views on SlideShare
5,563
Embed Views
29

Actions

Likes
2
Downloads
168
Comments
0

1 Embed 29

http://www.slideshare.net 29

Accessibility

Categories

Upload Details

Uploaded via as Microsoft PowerPoint

Usage Rights

© All Rights Reserved

Report content

Flagged as inappropriate Flag as inappropriate
Flag as inappropriate

Select your reason for flagging this presentation as inappropriate.

Cancel
  • Full Name Full Name Comment goes here.
    Are you sure you want to
    Your message goes here
    Processing…
Post Comment
Edit your comment
  • Formula can be rearranged to compute required return, if price and dividend known: Equity Valuation As will be discussed in chapter 5, the required return on common stock is based on its beta, derived from the CAPM Valuing CS is the most difficult, both practically & theoretically Preferred stock valuation is much easier (the easiest of all) Whenever investors feel the expected return, rˆ , is not equal to the required return, r , prices will react: If exp return declines or reqd return rises, stock price will fall If exp return rises or reqd return declines, stock price will rise Asset prices can change for reasons besides their own risk Changes in asset’s liquidity, tax status can change price Changes in market risk premium can change all asset values Most dramatic change in market risk: Russian default Fall 98 Caused required return on all risky assets to rise, price to fall
  • Formula can be rearranged to compute required return, if price and dividend known: Equity Valuation As will be discussed in chapter 5, the required return on common stock is based on its beta, derived from the CAPM Valuing CS is the most difficult, both practically & theoretically Preferred stock valuation is much easier (the easiest of all) Whenever investors feel the expected return, rˆ , is not equal to the required return, r , prices will react: If exp return declines or reqd return rises, stock price will fall If exp return rises or reqd return declines, stock price will rise Asset prices can change for reasons besides their own risk Changes in asset’s liquidity, tax status can change price Changes in market risk premium can change all asset values Most dramatic change in market risk: Russian default Fall 98 Caused required return on all risky assets to rise, price to fall

Financial Management Investment Appraisal Presentation Transcript

  • 1. ACCA 2.4 Financial Management & Control Lecture 10 Appraisal of Investments
  • 2. What is Finance?
    • A discipline mixing Accounting & Economics
    • Considers
      • Theoretical Context & Processes of the ways the “Economic Entity” raises funds from outside the entity
      • The way it should or does apply these funds
      • To create “Value” for the providers of funds
  • 3. What Managers Should Be Doing
    • Invest in projects that yield a return greater than the minimum acceptable rate .
      • The rate should be higher for riskier projects and reflect the financing mix used - owners’ funds (equity) or borrowed money (debt)
      • Returns on projects should be measured based on cash flows generated and the timing of these cash flows
      • they should also consider both positive and negative side effects of these projects.
    • Choose a financing mix that minimizes the required rate and matches the assets being financed.
  • 4. What Managers Should Be Doing
    • If there are not enough investments that earn the hurdle rate, return the cash to shareholders.
      • The form of returns - dividends and share buybacks - will depend upon the shareholders’ characteristics .
    • Objective:
      • Maximize the Value of the Firm
  • 5. Investment Appraisal
  • 6. The Manager’s Duty
    • Invest in projects that yield a return greater than the minimum acceptable rate .
      • Returns on projects should be measured based on cash flows generated and the timing of these cash flows
      • The minimum acceptable rate should be higher for riskier projects and reflect the financing mix used - owners’ funds (equity) or borrowed money (debt)
      • they should also consider both positive and negative side effects of these projects
  • 7. Measuring the Project Cash Flow
    • Cash Flows on Projects Are
      • OUT
        • Purchase of Assets
          • Fixed Assets, Working Capital, Intangible Assets,
        • Operating Costs, Taxes
      • IN
        • Sales of Assets
          • Fixed Assets, Working Capital, Intangible Assets
        • Operating Income
    • Note Financing Costs are excluded from this cash flow – this would be double counting
  • 8. Question
  • 9. Measuring the Cash Flow
  • 10. The Cash Flow
    • The cash flow occurs during time periods
    • The initial outlay occurs in year zero
    • Depreciation is NOT a cash flow
      • It is an accounting convention which attempts to spread the cost of buying an asset over the time periods during which the asset will be used
      • This called the MATCHING PRINCIPLE – one of the fundamental accounting principles
    • Depreciation may be used for calculating the Profit for the purposes of tax computation
  • 11. Calculate the Cash Flow
  • 12. Time Value of Money
  • 13. Consider the Cash Flow
    • Consider the cash flow timing
    • Is £1 today worth more than £1 next year?
    • We must find some way of making the cash flows in each year equivalent to each other
  • 14. Future Value
    • The Value of a Lump Sum or Stream of Cash Payments at a Future Point in Time
    FV n = PV x (1+r) n
    • Future Value depends on:
      • Interest Rate
      • Number of Periods
      • Compounding Interval
  • 15. Future Value of £200 ( 4 Years, 7% Interest ) What if the Interest Rate Goes Up to 8% ? 0 1 2 3 4 PV = £200 End of Year FV 1 = £214 FV 2 = £228.98 FV 3 = £245 FV 4 = £262.16
  • 16. Future Value of £200 ( 4 Years, 8% Interest ) 0 1 2 3 4 PV = £200 End of Year Compounding – The Process of Earning Interest in Each Successive Year FV 1 = £216 FV 2 = £233.28 FV 3 = £251.94 FV 4 = £272.10
  • 17. The Power Of Compound Interest Periods 0% Future Value of One Pound (£) 1.00 0 2 4 6 8 10 12 14 16 18 20 22 24 10.00 15.00 20.00 25.00 30.00 5.00 10% 5% 15% 20% 40.00
  • 18. Present Value
    • Today's Value of a Lump Sum or Stream of Cash Payments Received at a Future Point in Time
  • 19. Present Value of £200 ( 4 Years, 7% Interest ) What if the Interest Rate Goes Up to 8% ? 0 1 2 3 4 Discounting End of Year PV = £200 FV1 = £214 FV2 = £228.98 FV3 = £245 FV4 = £262.16
  • 20. Present Value of £200 ( 4 Years, 8% Interest ) 0 1 2 3 4 Discounting End of Year PV = £200 FV1 = £216 FV2 = £233.28 FV3 = £252 FV4 = £272.10
  • 21. The Power Of High Discount Rates Periods Present Value of One Pound (£) 0 2 4 6 8 10 12 14 16 18 20 22 24 0.5 0.75 1.00 0.25 10% 5% 15% 20% 0%
  • 22. Present Value Summary
    • Much Of Finance Involves Finding Future And (Especially) Present Values
    • Central To All Financial Valuation Techniques
    • Techniques Used By Investors & Firms Alike
  • 23. Discounting the cash flow: Question 6
    • Cost of Capital is 10%
  • 24. Other Methods of Investment Appraisal
    • Payback period
    • How long is it before we get our money back
  • 25. Payback Period Critique
    • Measures how long funds are at risk
    • Simple to calculate
    • BUT
    • Does not take into account cash flows after the payback
  • 26. Other Methods of Investment Appraisal
    • Accounting Rate of Return (ARR)
  • 27. Accounting Rate of Return Critique
    • Does not take account of timing of cash flows
    • Spreads costs of assets over asset life
    • Reality is that cash flows out when asset is purchased
      • Profit is a Concept
      • Cash is a Reality
  • 28. Other methods
    • Internal Rate of Return
      • Similar to Net Present Value
    • Involves calculating which rate of return will make Net Present Value = zero and comparing this with required rate of return
    • Inferior to NPV
      • More complex to calculate
      • Can give multiple rates if large negative cash flows at end of project
  • 29. The Manager’s Duty
    • Invest in projects that yield a return greater than the minimum acceptable rate .
      • Returns on projects should be measured based on cash flows generated and the timing of these cash flows
      • The minimum acceptable rate should be higher for riskier projects and reflect the financing mix used - owners’ funds (equity) or borrowed money (debt)
      • they should also consider both positive and negative side effects of these projects