CAPITAL BUDGETING

624 views

Published on

0 Comments
0 Likes
Statistics
Notes
  • Be the first to comment

  • Be the first to like this

No Downloads
Views
Total views
624
On SlideShare
0
From Embeds
0
Number of Embeds
1
Actions
Shares
0
Downloads
15
Comments
0
Likes
0
Embeds 0
No embeds

No notes for slide

CAPITAL BUDGETING

  1. 1. PRODUCT DEVELOPMENT “ Creating Value Internally”
  2. 2. TYPES OF CAPITAL EXPENDITURES <ul><li>PURCHASE NEW EQUIPMENT </li></ul><ul><li>REPLACE EXISTING ASSETS </li></ul><ul><li>INVESTMENTS IN WORKING CAPITAL </li></ul><ul><li>MERGER AND ACQUISITION ANALYSIS </li></ul>
  3. 3. THE CAPITAL BUDGETING PROCESS <ul><li>GENERATE PROJECT PROPOSALS </li></ul><ul><li>ESTIMATE CASH FLOWS </li></ul><ul><li>EVALUATE ALTERNATIVES </li></ul><ul><li>SELECT PROJECTS </li></ul>
  4. 4. ESTIMATING CASH FLOWS <ul><li>CASH FLOWS MUST BE INCREMENTAL </li></ul><ul><li>USE AFTER TAX CASH FLOWS </li></ul><ul><li>INDIRECT EFFECTS MUST BE INCLUDED </li></ul><ul><li>SUNK COSTS MUST NOT BE CONSIDERED </li></ul><ul><li>USE OPPORTUNITY COSTS TO MEASURE VALUE OF RESOURCES </li></ul>
  5. 5. NET INVESTMENT IS THE INITIAL CASH OUTLAY <ul><li>PROJECT COST PLUS SHIPPING AND INSTALLATION </li></ul><ul><li>PLUS </li></ul><ul><li>INCREASES IN NET WORKING CAPITAL </li></ul><ul><li>MINUS </li></ul><ul><li>PROCEEDS FROM SALE OF EXISTING ASSETS </li></ul><ul><li>MINUS </li></ul><ul><li>TAXES ASSOCIATED WITH SALE OF OLD </li></ul><ul><li>EQUALS </li></ul><ul><li>NET INVESTMENT </li></ul>
  6. 6. CASH FLOWS AFTER TAX <ul><li>CHANGE IN REVENUE </li></ul><ul><li>LESS: CHANGE IN OPERATING COSTS </li></ul><ul><li>LESS : CHANGE IN DEPRECIATION </li></ul><ul><li>EQUALS : CHANGE IN OPERATING EARNINGS </li></ul><ul><li>LESS : TAXES </li></ul><ul><li>EQUALS : CHANGE IN AFTER TAX OPERATING EARNINGS </li></ul><ul><li>PLUS : CHANGE IN DEPRECIATION </li></ul><ul><li>LESS : CHANGE IN NET WORKING CAPITAL </li></ul><ul><li>EQUALS : NET CASH FLOW </li></ul>
  7. 7. DECISION CRITERIA <ul><li>NET PRESENT VALUE </li></ul><ul><li>INTERNAL RATE OF RETURN </li></ul><ul><li>PROFITABILITY INDEX </li></ul><ul><li>PAYBACK PERIOD </li></ul>
  8. 8. NET PRESENT VALUE Present value of an investment = discounted value of cash flows- investment PV = future cash flows - Investment = + + + -
  9. 9. DISCOUNT FACTOR the amount by which cash flows received in the future lose value DF =
  10. 10. DISCOUNT FACTOR Discount Factor for cash flows discounted for one year at 10% DF= 1/1.10 = .909 Discount Factor for cash flows discounted for two years at 5% DF= 1/(1.05) 2 = .952
  11. 11. NPV- EXAMPLE PV= (CFAT)/(1+R) N + (CFAT)/(1+R) N+1 PV =(100)/(1.10) 1 + (100)/(1.10) 2 PV= (100)(.909) + (100)(.826) PV= 173.50
  12. 12. SUBTRACT NET INVESTMENT <ul><li>Net investment is the initial cash outlay for the project </li></ul><ul><li>Discounted Cash Flow - Investment= NPV </li></ul>Decision Rule: If NPV> 0, Accept Project
  13. 13. NPV - EXAMPLE <ul><li>IF NINV IS $150, THEN; </li></ul><ul><li>NPV = $173.50 - 150 = $23.50 </li></ul>
  14. 14. INTERNAL RATE OF RETURN The interest rate that equates DCF with Net Investment $100/(1+ R) 1 + $100/(1+R) 2 = $150 IRR = .10
  15. 15. PAYBACK PERIOD (PB) <ul><li>PB = NET INVESTMENT/ANNUAL CASH FLOWS </li></ul><ul><li>PB = $150/$100 = 1.50 YEARS </li></ul>
  16. 16. PROFITABILITY INDEX <ul><li>PI= PV of CASH FLOWS </li></ul><ul><li>NINV </li></ul><ul><li>PI = $90.90 + $82.60 </li></ul>$ 150 = 1.16
  17. 17. Management 290 business policy exercise Calculate the net present value of a project with a net investment of $20,000 for equipment and an additional net working capital investment of $5,000 at time zero. The project is expected to generate net cash flows of $7,000 per year over a 10 year period. In addition the working capital will be recovered at the end of the tenth year. The required rate of return on the project is 11%. What is the meaning of the computed net present value figure.
  18. 18. CLUB MED <ul><li>THE BUSINESS THEY ARE IN; </li></ul><ul><li>They operated more than 100 villages in 36 countries </li></ul><ul><li>The 1970’s image- “ a round trip ticket to sun,sea,…, and sex </li></ul><ul><li>1997 loss was more than $230 million </li></ul><ul><li>They had lost family and younger segments </li></ul><ul><li>THE STRATEGIC PLAN -Three year, $580 million outlay; </li></ul><ul><li>Advertising campaign aimed at families </li></ul><ul><li>offer off-peak prices and packages </li></ul><ul><li>close unprofitable villages- save $30 million annually </li></ul><ul><li>renovate two-thirds of the remaining ones -renovation to last for 7 years </li></ul>
  19. 19. CLUB MED <ul><li>THE $58 MILLION PLAN; </li></ul><ul><li>$330 million in renovations (26 villages) </li></ul><ul><li>$180 million for marketing and advertising </li></ul><ul><li>$70 million for working capital </li></ul><ul><li>THE FINANCING; </li></ul><ul><li>Issue $70 million in common stock </li></ul><ul><li>Borrow $270 million in short term notes (from bank) </li></ul><ul><li>Issue $140 million in debt (bonds) </li></ul>
  20. 20. CLUB MED THE RESULTS ; European revenues rose 9.7% to $1 billion Canned 70 of Club Med’s middle managers Fired 13 of 14 top managers Cut $15 million from operating budget Closed eight villages In 1998, earned $30 million on revenues of $1.5 billion Stock price recovered to $103 from $70 (1997)

×