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Concepts such as time value of money, simple interest, compound interest, CARG, cash-flows, WACC, inflation, discounting and capitalizing cash-flows are covered; in order to analyse and determine the economic feasibility of a project and what is the intrinsic or fair value of a company introducing discounted cash-flow techniques and multiples valuation

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- 1. INVESTMENTwww.antonioalcocer.com@antonioalcocer appraisal
- 2. INVESTMENT APPRAISAL METHODS 1. NET PRESENT VALUE (NPV) 2. INTERNAL RATE OF RETURN (IRR) 3. PAYBACK PERIOD www.antonioalcocer.com(*) Most important discussed
- 3. GOLDEN RULE www.antonioalcocer.com “We always work with cash-flows in investment appraisal”
- 4. “Cash-flow is a fact, net income just an opinion” -Pablo Fernández IESE-The net income amount is affected by accounting methods & assumptions made(i.e. depreciation & amortization that are not “real” cash inflows or outflows) www.antonioalcocer.comCash-flows are real money “entering” or “exiting” the company or project
- 5. P&L (*) Net sales -Cost of goods sold GROSS PROFIT HOW GOOD IS YOUR BUSINESS -Selling, General & Administration GENERATING “$” DUE THE OWN -Other operating expenses NATURE OF THE BUSINESS EBITDA -Depreciation & Amortization -Impairment EBIT -Interests FINANCING STRUCTURE INCOME BEFORE TAXES -Taxes CORPORATE TAXES FRAMEWORK NET INCOME(*) P&L=Profit & Loss account simplifiedP&L and Net Income are affected due to the accounting methods usedNet income is an opinion due to it depends on the calculationof the cost of goods sold, amortization method used & impairmentNet income is not real cash-flow outlays of money www.antonioalcocer.comDepreciation, amortization & impairment are not real cash-flow outlays
- 6. “So now I understand in investment appraisal we use CASH-FLOWS”www.antonioalcocer.com
- 7. But how many cash-flows exist?www.antonioalcocer.com
- 8. Free CASH-FLOW of the project (FCFF)= Available “$” for the funds providers: _BANKS _SHAREHOLDERSwww.antonioalcocer.com
- 9. www.antonioalcocer.com Free CASH-FLOW of the project (FCFF)= +EBIT (1-t) X +D&A +/-WORKING CAPITAL CHANGE -CAPEXFCFF= Real money generated by the project after accounting adjustments (no real cashflows outlays)D&A=Depreciation & Amortization (added because no real cash-outlay happened)CAPEX=Capital Expenditures (Investment in fixed assets)Working Capital Change= Investment in current assetst=Corporate taxes in %(*) Simplified formula of the cashflow, there are other terms: non-cash transactions adjustments, other current assets changes, proceeds from long term assets sales, changes in long term assets; to be considered
- 10. Equity Free CASH-FLOW (FCFE)= Available “$” for the equity providers: _SHAREHOLDERSwww.antonioalcocer.com
- 11. www.antonioalcocer.com Equity Free CASH-FLOW (FCFE)= +FCFF +PROCEEDS NEW BANKING DEBT - AMORTIZATION CURRENT DEBT - INTERESTS OF DEBT * (1-t) - DIVIDENDS PAID & T.S. REPUR.FCFE=Equity free cash-flow.Cash-flow available for shareholders after paying the banking funs providers.FCFE would be the money available for shareholdersT.S. REPUR= Treasury stock repurchase
- 12. …and many otherswww.antonioalcocer.com
- 13. NOWWE ARE READYFOR AN EXAMPLE!www.antonioalcocer.com
- 14. Investment appraisal of a project with these free-cashflows + +$300m +$175m +$200m t0=0 t1=1 t2=2 t3=3 -$150m -$300m -Diagram of the project free-cashflows (FCFF)Data in millions of US$ www.antonioalcocer.comYearly data
- 15. Houston, we have a problem:Funding needed:$300 mill. in 1st year$150 mill. in 2nd year www.antonioalcocer.com
- 16. Don’t worry Funds providers: _banks _shareholders will gently dispose themwww.antonioalcocer.com
- 17. “OK, have your funds, but [BANK] at a 6.6% annual interest rate rat & maximum amount 65% Kd= 6.6%www.antonioalcocer.com
- 18. Ke= 20% [SHAREHOLDERS] “OK, have your funds, but at a 20% annual interest rate & 35% maximum amount”www.antonioalcocer.com
- 19. So, which amount/ratio should I ask for Don E. Botín [banks] & Don C. Slim [shareholders]?www.antonioalcocer.com
- 20. It seems clear that The cost of financing this project Would be the Weighted average Cost of capital WACCwww.antonioalcocer.com
- 21. OPTIMAL FINANCING STRUCTURE www.antonioalcocer.com [BANK] 50% 60% 65% [SHAREHOLDERS] 50% 40% 35% WACC Cheapest 12.31% 10.77% 10%WACC= % equity * expected return on equity + % banking_debt*(1-corporate tax)*cost of banking debtWACC= 35%*20%+65%*(1-30%)*6.6%=10%
- 22. So the $300 mill. + $150 mill. will be financed by a 65% banking debt by a 35% shareholders’ equity with a WACC=10%www.antonioalcocer.com
- 23. Profitability of the project = 50% in 3-years? www.antonioalcocer.com +$300m +$175m +$200m t0=0 t1=1 t2=2 t3=3 -$150m -$300m +300 + 175 + 200 - 300 - 150 %return= = 50% 450Diagram of the project free-cashflows (FCFF)Data in millions of US$Yearly data
- 24. Noooooo!!!!!!!!! TIME VALUE OF MONEYwww.antonioalcocer.com
- 25. INVESTMENT APPRAISAL METHODS 1. NET PRESENT VALUE (NPV) 2. INTERNAL RATE OF RETURN (IRR) 3. PAYBACK PERIOD(*) Most important discussed www.antonioalcocer.com
- 26. 1. NET PRESENT VALUE = NPV www.antonioalcocer.com1) All FCFF are discounted to today & summed2) Using compound interest formula3) At a WACC rate
- 27. www.antonioalcocer.com 1. NET PRESENT VALUE=$0 [Undertake project]Cash-flows generated exactly pay the cash-flows expectations requested bythe banking & shareholders (funds providers)
- 28. 1. NET PRESENT VALUE>$0 www.antonioalcocer.com[Undertake project]Cash-flows generated pay all the cash-flows requested by fund providers inorder to meet their profit expectations (NPV=0) & additional cash-flow=NPVgoes as excess profit for shareholders
- 29. www.antonioalcocer.com1. NET PRESENT VALUE<$0 [Do not undertake project]Cash-flows generated are not enoughto pay the cash-flows demmands byfunds providers according to theirprofit expectations (=WACC)
- 30. 1. Net present value = NPV – WACC=10% www.antonioalcocer.com +$300m +$175m +$200m t0=0 t1=1 t2=2 t3=3 -$150m -$300m Undertake project NPV>0 +300 -150 +175 +200 NPV = $131.2 = -300 + + + (1+10%)^1 (1+10%)^2 (1+10%)^3Diagram of the project free-cashflows (FCFF)Data in millions of US$Yearly data+$131.2 million of excess cash-flow that shareholders get above their profit (20%) & cash-flow expectations
- 31. 2. INTERNAL RATE OF RETURN (IRR) = Project’s CAGR = _solve NPV=0 _get IRRwww.antonioalcocer.com
- 32. 2. Internal Rate of Return (IRR) = 32.24% > WACC =10% Undertake project +$300m +$175m +$200m t0=0 t1=1 t2=2 t3=3 -$150m -$300m Solve non-linear equation +300 -150 +175 +200 NPV = $0 = -300 + + + (1+IRR)^1 (1+IRR)^2 (1+IRR)^3Diagram of the project free-cashflows (FCFF)Data in millions of US$Yearly data www.antonioalcocer.comIRR is obtained solving the equation
- 33. 1&2. Net present value summary IRR>WACC NPV>0 Fund providers more than happy NPV excess for shareholders IRR=WACC NPV=0 Fund providers exactly happy Fund providers unhappy IRR<WACC NPV<0www.antonioalcocer.com
- 34. 3. PAYBACK PERIOD Years to recover investment… …you better payExpected number of years in ordercumulative (+) cash-flows>= www.antonioalcocer.comcumulative (-) cash-flows
- 35. 3. Payback period= 1.85 years www.antonioalcocer.com +$300m +$175m +$200m t0=0 t1=1 t2=2 t3=3 -$150m -$300m Cumulative -300 -300+300-150 -300+300-150+175 -300+300-150+175+200 -300 -150 +25 +225Payback period does not take into account time value of money, so it should not be used in a stand alone basis but as complementary info to NPV and IRRDiagram of the project free-cashflows (FCFF)Data in millions of US$Yearly dataPayback period: Positive cumulative cashflows are > negative cumulative cashflows in year 1-2175/12=14.58-150/14.58=10.29 months = 10.29/12= 0.85 years
- 36. www.antonioalcocer.comRE Investment appraisal methods Project free cashflowsWe have learnt: WACC NPV IRR Payback
- 37. Thank you very much for you time!Any comment, suggestion is more than welcome: www.antonioalcocer.com

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