2.
Principles of Corporate Finance <ul><li>Chapter 5 </li></ul><ul><li>Why Net Present Value Leads to Better Investment Decisions than Other Criteria </li></ul>
5.
IRR <ul><li>IRR stands for Internal Rate of Return. </li></ul><ul><li>It is a Capital Budgeting Techniqe. </li></ul><ul><li>More difficult than NPV. </li></ul><ul><li>The Decision Criteria </li></ul><ul><li>If IRR > Cost of capital, Accept the project. </li></ul><ul><li>If IRR < Cost of capital, Reject the project. </li></ul>
7.
PRESENT VALUE Present value is the currant dollar value of a future amount_the amount of money that would have to be invested today at a given interest rate over a specified period to equal the future amount.
8.
FORMULA OF PERESENT VALUE <ul><li>PV= FV /(1+i)n </li></ul><ul><li>For example how much would I have to deposit today into a account paying 7% annual interest to accumulate 3000$ at the end of 5 years. </li></ul>
9.
NET PRESENT VALUE <ul><li>A sophisticated capital budgeting technique; found by subtracting a projects initial investment from the present value of its cash inflows discounted at a rate equal to the firms cost of capital </li></ul><ul><li>NPV= Present value of cash inflows - Initial investment </li></ul>
10.
THE DECISION CRITERIA <ul><li>When NPV IS used to make accept_reject decisions, the decision criteria as follows, </li></ul><ul><li>If the NPV is greater than $0 accept the project. </li></ul><ul><li>If the NPV is less than $0 reject the project. </li></ul>
11.
NPV COMPETITORS <ul><li>IRR </li></ul><ul><li>PAYBACK </li></ul><ul><li>BOOK RATE OF RETURN </li></ul>
12.
Three points to Remember about NPV <ul><li>First the NPV Rule recognizes that a rupee today is worth more than a rupee tomorrow. </li></ul><ul><li>NPV depends solely on the forecasted cash flow from the project and the opportunity cost of capital. </li></ul><ul><li>Because present value are all measured in todays rupees, you can add them up. </li></ul>
14.
Payback period <ul><li>The amount of time required for a firm to cover its initial investment in a project, as calculated by cash inflow. </li></ul>
15.
Decision criteria <ul><li>When the payback period is used to make accept_reject decions,the decision criteria as follows </li></ul><ul><li>If the payback period is less than the maximum acceptable payback period, accept the project. </li></ul><ul><li>If the payback period is greater than the maximum acceptable payback period, reject the project </li></ul>
16.
Payback <ul><li>Example </li></ul><ul><li>Examine the three projects and note the mistake we would make if we insisted on only taking projects with a payback period of 2 years or less. </li></ul>
18.
Profitability Index <ul><li>When resources are limited, the profitability index (PI) provides a tool for selecting among various project combinations and alternatives </li></ul><ul><li>A set of limited resources and projects can yield various combinations. </li></ul><ul><li>The highest weighted average PI can indicate which projects to select. </li></ul>
19.
NPV = sum of the P.V of cash inflow - initial investment
20.
Choosing The Capital Investment When resources are Limited: The opportunity cost of capital is 10% and our company has the following opportunity . Cash Flow(RS. Millions) 12 +15 +5 -5 C 16 +20 +5 -5 B 21 +5 +30 -10 A NPV at 10 % C3 C2 C1 Project
21.
Profitability Index: Profitability Index =Net P.V / investment
22.
For our three projects the profitability index is calculated as follows: 2.1 21 10 A 2.4 12 5 C 3.2 16 5 B Profitability index NPV Rs.millions Investment Rs.millions Project
24.
PRESENT VALUE Present value is the currant dollar value of a future amount_the amount of money that would have to be invested today at a given interest rate over a specified period to equal the future amount.
25.
FORMULA OF PERESENT VALUE <ul><li>PV= FV /(1+i)n </li></ul><ul><li>For example how much would I have to deposit today into a account paying 7% annual interest to accumulate 3000$ at the end of 5 years. </li></ul>
26.
NET PRESENT VALUE <ul><li>A sophisticated capital budgeting technique; found by subtracting a projects initial investment from the present value of its cash inflows discounted at a rate equal to the firms cost of capital </li></ul><ul><li>NPV= Present value of cash inflows - Initial investment </li></ul>
27.
THE DECISION CRITERIA <ul><li>When NPV IS used to make accept_reject decisions, the decision criteria as follows, </li></ul><ul><li>If the NPV is greater than $0 accept the project. </li></ul><ul><li>If the NPV is less than $0 reject the project. </li></ul>
28.
NPV COMPETITORS <ul><li>IRR </li></ul><ul><li>PAYBACK </li></ul><ul><li>BOOK RATE OF RETURN </li></ul>
29.
Three points to Remember about NPV <ul><li>First the NPV Rule recognizes that a rupee today is worth more than a rupee tomorrow. </li></ul><ul><li>NPV depends solely on the forecasted cash flow from the project and the opportunity cost of capital. </li></ul><ul><li>Because present value are all measured in todays rupees, you can add them up. </li></ul>
31.
Payback period <ul><li>The amount of time required for a firm to cover its initial investment in a project, as calculated by cash inflow. </li></ul>
32.
Decision criteria <ul><li>When the payback period is used to make accept_reject decions,the decision criteria as follows </li></ul><ul><li>If the payback period is less than the maximum acceptable payback period, accept the project. </li></ul><ul><li>If the payback period is greater than the maximum acceptable payback period, reject the project </li></ul>
33.
Payback <ul><li>Example </li></ul><ul><li>Examine the three projects and note the mistake we would make if we insisted on only taking projects with a payback period of 2 years or less. </li></ul>
35.
IRR <ul><li>IRR stands for Internal Rate of Return. </li></ul><ul><li>It is a Capital Budgeting Techniqe. </li></ul><ul><li>More difficult than NPV. </li></ul><ul><li>The Decision Criteria </li></ul><ul><li>If IRR > Cost of capital, Accept the project. </li></ul><ul><li>If IRR < Cost of capital, Reject the project. </li></ul>
38.
Profitability Index <ul><li>When resources are limited, the profitability index (PI) provides a tool for selecting among various project combinations and alternatives </li></ul><ul><li>A set of limited resources and projects can yield various combinations. </li></ul><ul><li>The highest weighted average PI can indicate which projects to select. </li></ul>
39.
NPV = sum of the P.V of cash inflow - initial investment
40.
Choosing The Capital Investment When resources are Limited: The opportunity cost of capital is 10% and our company has the following opportunity . Cash Flow(RS. Millions) 12 +15 +5 -5 C 16 +20 +5 -5 B 21 +5 +30 -10 A NPV at 10 % C3 C2 C1 Project
41.
Profitability Index: Profitability Index =Net P.V / investment
42.
For our three projects the profitability index is calculated as follows: 2.1 21 10 A 2.4 12 5 C 3.2 16 5 B Profitability index NPV Rs.millions Investment Rs.millions Project
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