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Which one you go for?? <ul><li>Nokia E-71   Nokia 6030   Nokia 3310 </li></ul>
Presented By N oman A nil   F ahad A dil RISK IN CAPITAL BUDGETING AND TIME VALUE OF MONEY
Investors Main Strategies
 
Simple & Compound Interest <ul><li>Simple Interest:  </li></ul><ul><li>Interest continues to accrue over a period of time ...
Future & Present value <ul><li>Future Value :  </li></ul><ul><li>Value that money will acquire in future, if compounded at...
 
What is Capital Budgeting? <ul><li>Capital budgeting is used to determine the requirements of the long-term investments of...
Purpose…
Planning for Capital Assets
Approaches <ul><li>NPV: </li></ul><ul><li>If we consider a series of cash flows, and compute present values of all the cas...
Approaches <ul><li>Profitability Index: </li></ul><ul><li>A ratio of whether and how much an investment will result in a p...
 
Relevant Risks in Capital Budgeting <ul><li>Stand-alone risk </li></ul><ul><li>Corporate risk </li></ul><ul><li>Market (or...
Stand-Alone Risk <ul><ul><li>The project’s risk if it were the firm’s only asset and there were no shareholders. </li></ul...
Corporate Risk <ul><ul><li>Reflects the project’s effect on corporate earnings stability. </li></ul></ul><ul><ul><li>Consi...
Market Risk <ul><ul><li>Reflects the project’s effect on a well-diversified stock portfolio. </li></ul></ul><ul><ul><li>Ta...
Risk Analysis in Capital Budgeting <ul><li>Scenario Analysis </li></ul><ul><li>Simulation Analysis </li></ul><ul><li>Decis...
Scenario Analysis <ul><li>Examines several possible situations, usually  worst  case,  most likely  case, and  best  case....
Examples Scenario   Probability   NPV(000) Worst  0.25 $  15 Base  0.50 82   Best  0.25 148 E(NPV) = $  82  (NPV) =  47 C...
Simulation Analysis <ul><li>A computerized version of scenario analysis which uses  continuous probability distributions ....
Example <ul><li>NPV and IRR are calculated. </li></ul><ul><li>Process is repeated many times (1,000 or more). </li></ul><u...
 
 
Noman Usman Anil Saleem Fahad Ali Adil Rahman
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Risk In Capital Budgeting

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Risk In Capital Budgeting

  1. 1. Which one you go for?? <ul><li>Nokia E-71 Nokia 6030 Nokia 3310 </li></ul>
  2. 2. Presented By N oman A nil F ahad A dil RISK IN CAPITAL BUDGETING AND TIME VALUE OF MONEY
  3. 3. Investors Main Strategies
  4. 5. Simple & Compound Interest <ul><li>Simple Interest: </li></ul><ul><li>Interest continues to accrue over a period of time at a given rate. </li></ul><ul><li>SI = P(r)(n) </li></ul><ul><li>Compounding of interest: </li></ul><ul><li>compensation for the investor not actually receiving interest periodically. </li></ul><ul><li>A = P (1+ r)n </li></ul>
  5. 6. Future & Present value <ul><li>Future Value : </li></ul><ul><li>Value that money will acquire in future, if compounded at a given rate of return. </li></ul><ul><li>FV = PV (1+r)n </li></ul><ul><li>Present Value: </li></ul><ul><li>Value of money that is expected in future, today . </li></ul><ul><li>PV = FV/ (1+r)n </li></ul>
  6. 8. What is Capital Budgeting? <ul><li>Capital budgeting is used to determine the requirements of the long-term investments of a company. Examples of long-term investments are those required for replacement of equipments and machinery. </li></ul>
  7. 9. Purpose…
  8. 10. Planning for Capital Assets
  9. 11. Approaches <ul><li>NPV: </li></ul><ul><li>If we consider a series of cash flows, and compute present values of all the cash flows at a particular discounting rate, and then sum up the present values, the result is called net present value . </li></ul><ul><li>NPV = CF0 – (CF1/(1+r)1 +CF2/(1+r)2+ .....+CFn/(1+r)n) </li></ul><ul><li>IRR: </li></ul><ul><li>The word internal or implicit is only to state that on the face of it, the rate was not explicit. </li></ul><ul><li>IRR is the rate where NPV = 0 </li></ul><ul><li>NPV = 0 = CF0 – (CF1/(1+r)1 +CF2/(1+r)2+ .....+CFn/(1+r)n) </li></ul><ul><li>Or; CF0 = (CF1/(1+r)1 +CF2/(1+r)2+ .....+CFn/(1+r)n) </li></ul><ul><li>  </li></ul>
  10. 12. Approaches <ul><li>Profitability Index: </li></ul><ul><li>A ratio of whether and how much an investment will result in a profit. It is calculated by taking the NPV of expected future cash flows from an investment and dividing by the investment's original cost. A ratio above one indicates that the investment will be profitable, while a ratio below one means that it will not. </li></ul><ul><li>PI=PV of future cash flows/ Initial Investment </li></ul><ul><li>Payback Period: </li></ul><ul><li>The length of time it takes to recover the cost of an investment. It is calculated as shown here: </li></ul><ul><li> PB= Cost of Project/ Annual Cash Inflows </li></ul>
  11. 14. Relevant Risks in Capital Budgeting <ul><li>Stand-alone risk </li></ul><ul><li>Corporate risk </li></ul><ul><li>Market (or beta) risk </li></ul>
  12. 15. Stand-Alone Risk <ul><ul><li>The project’s risk if it were the firm’s only asset and there were no shareholders. </li></ul></ul><ul><ul><li>Ignores both firm and shareholder diversification. </li></ul></ul><ul><ul><li>Measured by the  or CV of NPV, IRR, or MIRR. </li></ul></ul>
  13. 16. Corporate Risk <ul><ul><li>Reflects the project’s effect on corporate earnings stability. </li></ul></ul><ul><ul><li>Considers firm’s other assets (diversification within firm). </li></ul></ul><ul><ul><li>Depends on: </li></ul></ul><ul><ul><ul><li>project’s  , and </li></ul></ul></ul><ul><ul><ul><li>its correlation with returns on firm’s other assets. </li></ul></ul></ul><ul><ul><li>Measured by the project’s corporate beta. </li></ul></ul>
  14. 17. Market Risk <ul><ul><li>Reflects the project’s effect on a well-diversified stock portfolio. </li></ul></ul><ul><ul><li>Takes account of stockholders’ other assets. </li></ul></ul><ul><ul><li>Depends on project’s  and correlation with the stock market. </li></ul></ul><ul><ul><li>Measured by the project’s market beta. </li></ul></ul>
  15. 18. Risk Analysis in Capital Budgeting <ul><li>Scenario Analysis </li></ul><ul><li>Simulation Analysis </li></ul><ul><li>Decision Tree Analysis </li></ul>
  16. 19. Scenario Analysis <ul><li>Examines several possible situations, usually worst case, most likely case, and best case. </li></ul><ul><li>Provides a range of possible outcomes. </li></ul>
  17. 20. Examples Scenario Probability NPV(000) Worst 0.25 $ 15 Base 0.50 82 Best 0.25 148 E(NPV) = $ 82  (NPV) = 47 CV(NPV) =  (NPV)/E(NPV) = 0.57 Since CV = 0.57 > 0.4, this project has high risk .
  18. 21. Simulation Analysis <ul><li>A computerized version of scenario analysis which uses continuous probability distributions . </li></ul><ul><li>Computer selects values for each variable based on given probability distributions. </li></ul>
  19. 22. Example <ul><li>NPV and IRR are calculated. </li></ul><ul><li>Process is repeated many times (1,000 or more). </li></ul><ul><li>End result: Probability distribution of NPV and IRR based on sample of simulated values. </li></ul><ul><li>Also gives  NPV , CV NPV , probability of NPV > 0. </li></ul>
  20. 25. Noman Usman Anil Saleem Fahad Ali Adil Rahman

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