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  • tilkommer

    1. 1. FARM MANAGEMENT <ul><li>WK 5: CAPITAL BUDGETS </li></ul><ul><li>(INVESTMENT ANALYSIS) </li></ul>MM WATERLOO
    2. 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: Estate Planning </li></ul>
    3. 3. 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
    4. 4. 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
    5. 5. <ul><li>C. Types Of Investment Choices </li></ul>2. Preference: Which Is Best 1. Screening: Which Are Good Wk 5: Capital Budgets
    6. 6. D. Basis Of Decisions <ul><li>A. Style, “Paint Color” </li></ul><ul><li>B. Prestige, Image </li></ul>A. Profitability B. Rate Of Return 2. Quantitative: “Will It Pay” 1. Qualitative: “ What I Want” Wk 5: Capital Budgets
    7. 7. II. Capital Budget Steps <ul><li>A. Determine Cost Of Capital </li></ul><ul><li>Aft Tx Rate: Int Rate*(1-tx Rate) </li></ul><ul><li>+ Inflation Rate </li></ul><ul><li>+ Risk Factor </li></ul><ul><li>= Cost Of Capital </li></ul><ul><li>B. Determine Initial Investment </li></ul><ul><li>C. Determine Net Cash Flows </li></ul><ul><li>Net Cash = Cash Rec- Cash Exp </li></ul><ul><li>D. Estimate Terminal Value </li></ul><ul><li>E. Calculate Investment Measures </li></ul>Wk 5: Capital Budgets
    8. 8. III. Non-time Methods <ul><li>A. Payback </li></ul><ul><li>1. Advantages </li></ul><ul><li>A. Simple & Easy </li></ul><ul><li>B. Widely Used </li></ul><ul><li>C. Emphasizes Liquidity </li></ul><ul><li>2. Disadvantages </li></ul><ul><li>A. Profitability Not Considered </li></ul><ul><li>B. Cash Flows After Payback </li></ul><ul><li>Are Ignored </li></ul><ul><li>C. Time Value Of Money Ignored </li></ul>WK 5: Capital Budgets
    9. 9. 3. Pay Back 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><ul><li>Tot Revenue </li></ul><ul><li>Profit </li></ul><ul><li>Payback </li></ul>Lump $10,000 $0 $0 $0 $0 $15,000 Equal $48,000 $ 10,000 $10,000 $10,000 $10,000 $10,000 Unequal $4,000 $2,000 $2,000 $3,000 $15,000 $50,000 $7000 $5,000 $2,000 $3,000 4.66 Yr 4.8 Yr 2.0 Yr $0 $0 $0 WK 5: Capital Budgets
    10. 10. <ul><li>B. Acct Rate Of Ret & Book Rate </li></ul><ul><li>1. Advantages </li></ul><ul><li>A. Calculation Ease </li></ul><ul><li>B. Good For Screening </li></ul><ul><li>C. Gd For Short Life Projects </li></ul><ul><li>2. Disadvantages </li></ul><ul><li>A. Time Val Of $ Not Considered </li></ul><ul><li>B. Doesn’t Consider The Timing </li></ul><ul><li>Of The Flows </li></ul>WK 5: Capital Budgets
    11. 11. 3. Acct Rate Of Ret 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 Cash - Invest Time ========== > Investment 15,000 - 10,000 5 ========= > 10,000 5,000 5 ==== > 10,000 1000 ==== > 10,000 = 10% $0
    12. 12. <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 Cash - Invest Time ========== > Investment 50,000 - 48,000 5 ========= > 48,000 2,000 5 ==== > 48,000 400 ==== > 48,000 = .8% $48,000 $10,000 $10,000 $10,000 $10,000 $10,000 $0 WK 5: Capital Budgets
    13. 13. <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 Cash - invest Time ========== > Investment 7,000 - 4,000 3 ========= > 4,000 3,000 3 ==== > 4,000 1,000 ==== > 4,000 = 25% $4,000 $2,000 $2,000 $3,000 $0 WK 5: Capital Budgets
    14. 14. 4. Book Rate Of Ret 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 Cash - Invest No Of Flows Invest + Salv 2 15,000 - 10,000 5 ========= > 5,000 5,000 5 ==== > 5,000 1000 ==== > 5,000 = 20% $10,000 $0 $0 $0 $0 $15,000 $0
    15. 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>Equal 50,000 - 48,000 5 ========= > 24,000 2,000 5 ==== > 24,000 400 ==== > 24,000 = 1.6% Cash - Invest No Of Flows ========================== Invest + Salv 2 48,000 10,000 10,000 10,000 10,000 10,000 $0 WK 5: Capital Budgets
    16. 16. <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 7,000 - 4,000 3 ========= > 2,000 3,000 3 ==== > 2,000 1,000 ==== > 2,000 = 50% Cash - Invest No Of Flows ======================== Invest + Salv 2 $4,000 $2,000 $2,000 $3,000 $0 WK 5: Capital Budgets
    17. 17. Non-time Summary <ul><li>Tot Rev </li></ul><ul><li>Profit </li></ul><ul><li>Payback </li></ul><ul><li>Acct Rate </li></ul><ul><li>Book Rate </li></ul>Lump Equal Unequal $50,000 $20,000 $7,000 $5,000 $2,000 $3,000 4.66 Yr 4.8 Yr 2.0 Yr 10% .8% 25% 20% 1.6% 50% WK 5: Capital Budgets
    18. 18. IV. Time Value Of Money A. Future Value WK 5: Capital Budgets 1 ...Of A Lump Sum ( Compounding) Looking Ahead 2 ...Of An Annuity (Regular Deposits) B. Present Value Looking Now 1 ...Of A Lump Sum ( Discounting) 2 ...Of An Annuity (Regular Deposits)
    19. 19. 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 WK 5: Capital Budgets
    20. 20. 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 WK 5: Capital Budgets
    21. 21. 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 WK 5: Capital Budgets
    22. 22. 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 WK 5: Capital Budgets
    23. 23. 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 = WK 5: Capital Budgets
    24. 24. 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>WK 5: Capital Budgets
    25. 25. 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
    26. 26. 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 = WK 5: Capital Budgets
    27. 27. <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 WK 5: Capital Budgets
    28. 28. <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 WK 5: Capital Budgets
    29. 29. 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
    30. 30. <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 WK 5: Capital Budgets
    31. 31. 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.X - X.X% 3 - 4 % Equal 4.8 5 Yr X.X- X.X% 3 - 4% Unequal 2.0 5 Yr X.X - X.X% 3- 4% WK 5: Capital Budgets
    32. 32. 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
    33. 33. 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
    34. 34. 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
    35. 35. 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 WK 5: Capital Budgets
    36. 36. 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
    37. 37. 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>
    38. 38. NEXT TOPIC <ul><li>TIMELINESS </li></ul>INTERNATIONAL HARVERSTER W4

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