Capital budgeting is the process of evaluating potential long-term investments and capital expenditures. It involves estimating cash flows, assessing risk, determining discount rates, and calculating metrics like net present value and internal rate of return to determine if a project is economically acceptable and should receive funding. Capital is a limited resource for companies, so capital budgeting helps management identify projects that will contribute most to profits and shareholder value. The key steps are to focus on incremental cash flows, account for the time value of money using techniques like NPV, and make go/no-go decisions on whether projects are worth undertaking based on their expected returns.
BlueBookAcademy.com Explains Capital Budgetingbluebookacademy
Lets run through the principles of capital budgeting, making sound financial decisions to allocate resources and finances effectively. Capital budgeting is widely used in corporate finance, project appraisal and many other applications. We cover the important concepts of net present values (NPV) and internal rates of return (IRR).
The slide is about evaluation of investment in projects before starting the project. Useful for Finance Manager, Finance Students, Entrepreneurs and Project Managers
BlueBookAcademy.com Explains Capital Budgetingbluebookacademy
Lets run through the principles of capital budgeting, making sound financial decisions to allocate resources and finances effectively. Capital budgeting is widely used in corporate finance, project appraisal and many other applications. We cover the important concepts of net present values (NPV) and internal rates of return (IRR).
The slide is about evaluation of investment in projects before starting the project. Useful for Finance Manager, Finance Students, Entrepreneurs and Project Managers
You have just graduated from the MBA program of a large university, and one of your favorite courses was “Today’s Entrepreneurs.” In fact, you enjoyed it so much you have decided you want to “be your own boss.” While you were in the master’s program, your grandfather died and left you $300,000 to do with as you please. You are not an inventor and you do not have a trade skill that you can market; however, you have decided that you would like to purchase at least one established franchise in the fast foods area, maybe two (if profitable). The problem is that you have never been one to stay with any project for too long, so you figure that your time frame is three years. After three years you will sell off your investment and go on to something else.
You have narrowed your selection down to two choices; (1) Franchise L: Lisa’s Soups, Salads, & Stuff and (2) Franchise S: Sam’s Wonderful Fried Chicken. The net cash flows shown below include the price you would receive for selling the franchise in year 3 and the forecast of how each franchise will do over the three-year period. Franchise L’s cash flows will start off slowly but will increase rather quickly as people become more health conscious, while Franchise S’s cash flows will start off high but will trail off as other chicken competitors enter the marketplace and as people become more health conscious and avoid fried foods. Franchise L serves breakfast and lunch, while franchise S serves only dinner, so it is possible for you to invest in both franchises. You see these franchises as perfect complements to one another: you could attract both the lunch and dinner crowds and the health conscious and not so health conscious crowds with the franchises directly competing against one another.
The investment decisions of a firm are generally known as the capital budgeting, or capital expenditure decisions.
The firm’s investment decisions would generally include expansion, acquisition, modernisation and replacement of the long-term assets. Sale of a division or business (divestment) is also as an investment decision.
Decisions like the change in the methods of sales distribution, or an advertisement campaign or a research and development programme have long-term implications for the firm’s expenditures and benefits, and therefore, they should also be evaluated as investment decisions.
Maximizing Your Streaming Experience with XCIPTV- Tips for 2024.pdfXtreame HDTV
In today’s digital age, streaming services have become an integral part of our entertainment lives. Among the myriad of options available, XCIPTV stands out as a premier choice for those seeking seamless, high-quality streaming. This comprehensive guide will delve into the features, benefits, and user experience of XCIPTV, illustrating why it is a top contender in the IPTV industry.
Meet Crazyjamjam - A TikTok Sensation | Blog EternalBlog Eternal
Crazyjamjam, the TikTok star everyone's talking about! Uncover her secrets to success, viral trends, and more in this exclusive feature on Blog Eternal.
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Skeem Saam in June 2024 available on ForumIsaac More
Monday, June 3, 2024 - Episode 241: Sergeant Rathebe nabs a top scammer in Turfloop. Meikie is furious at her uncle's reaction to the truth about Ntswaki.
Tuesday, June 4, 2024 - Episode 242: Babeile uncovers the truth behind Rathebe’s latest actions. Leeto's announcement shocks his employees, and Ntswaki’s ordeal haunts her family.
Wednesday, June 5, 2024 - Episode 243: Rathebe blocks Babeile from investigating further. Melita warns Eunice to stay clear of Mr. Kgomo.
Thursday, June 6, 2024 - Episode 244: Tbose surrenders to the police while an intruder meddles in his affairs. Rathebe's secret mission faces a setback.
Friday, June 7, 2024 - Episode 245: Rathebe’s antics reach Kganyago. Tbose dodges a bullet, but a nightmare looms. Mr. Kgomo accuses Melita of witchcraft.
Monday, June 10, 2024 - Episode 246: Ntswaki struggles on her first day back at school. Babeile is stunned by Rathebe’s romance with Bullet Mabuza.
Tuesday, June 11, 2024 - Episode 247: An unexpected turn halts Rathebe’s investigation. The press discovers Mr. Kgomo’s affair with a young employee.
Wednesday, June 12, 2024 - Episode 248: Rathebe chases a criminal, resorting to gunfire. Turf High is rife with tension and transfer threats.
Thursday, June 13, 2024 - Episode 249: Rathebe traps Kganyago. John warns Toby to stop harassing Ntswaki.
Friday, June 14, 2024 - Episode 250: Babeile is cleared to investigate Rathebe. Melita gains Mr. Kgomo’s trust, and Jacobeth devises a financial solution.
Monday, June 17, 2024 - Episode 251: Rathebe feels the pressure as Babeile closes in. Mr. Kgomo and Eunice clash. Jacobeth risks her safety in pursuit of Kganyago.
Tuesday, June 18, 2024 - Episode 252: Bullet Mabuza retaliates against Jacobeth. Pitsi inadvertently reveals his parents’ plans. Nkosi is shocked by Khwezi’s decision on LJ’s future.
Wednesday, June 19, 2024 - Episode 253: Jacobeth is ensnared in deceit. Evelyn is stressed over Toby’s case, and Letetswe reveals shocking academic results.
Thursday, June 20, 2024 - Episode 254: Elizabeth learns Jacobeth is in Mpumalanga. Kganyago's past is exposed, and Lehasa discovers his son is in KZN.
Friday, June 21, 2024 - Episode 255: Elizabeth confirms Jacobeth’s dubious activities in Mpumalanga. Rathebe lies about her relationship with Bullet, and Jacobeth faces theft accusations.
Monday, June 24, 2024 - Episode 256: Rathebe spies on Kganyago. Lehasa plans to retrieve his son from KZN, fearing what awaits.
Tuesday, June 25, 2024 - Episode 257: MaNtuli fears for Kwaito’s safety in Mpumalanga. Mr. Kgomo and Melita reconcile.
Wednesday, June 26, 2024 - Episode 258: Kganyago makes a bold escape. Elizabeth receives a shocking message from Kwaito. Mrs. Khoza defends her husband against scam accusations.
Thursday, June 27, 2024 - Episode 259: Babeile's skillful arrest changes the game. Tbose and Kwaito face a hostage crisis.
Friday, June 28, 2024 - Episode 260: Two women face the reality of being scammed. Turf is rocked by breaking
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From Slave to Scourge: The Existential Choice of Django Unchained. The Philos...Rodney Thomas Jr
#SSAPhilosophy #DjangoUnchained #DjangoFreeman #ExistentialPhilosophy #Freedom #Identity #Justice #Courage #Rebellion #Transformation
Welcome to SSA Philosophy, your ultimate destination for diving deep into the profound philosophies of iconic characters from video games, movies, and TV shows. In this episode, we explore the powerful journey and existential philosophy of Django Freeman from Quentin Tarantino’s masterful film, "Django Unchained," in our video titled, "From Slave to Scourge: The Existential Choice of Django Unchained. The Philosophy of Django Freeman!"
From Slave to Scourge: The Existential Choice of Django Unchained – The Philosophy of Django Freeman!
Join me as we delve into the existential philosophy of Django Freeman, uncovering the profound lessons and timeless wisdom his character offers. Through his story, we find inspiration in the power of choice, the quest for justice, and the courage to defy oppression. Django Freeman’s philosophy is a testament to the human spirit’s unyielding drive for freedom and justice.
Don’t forget to like, comment, and subscribe to SSA Philosophy for more in-depth explorations of the philosophies behind your favorite characters. Hit the notification bell to stay updated on our latest videos. Let’s discover the principles that shape these icons and the profound lessons they offer.
Django Freeman’s story is one of the most compelling narratives of transformation and empowerment in cinema. A former slave turned relentless bounty hunter, Django’s journey is not just a physical liberation but an existential quest for identity, justice, and retribution. This video delves into the core philosophical elements that define Django’s character and the profound choices he makes throughout his journey.
Link to video: https://youtu.be/GszqrXk38qk
Tom Selleck Net Worth: A Comprehensive Analysisgreendigital
Over several decades, Tom Selleck, a name synonymous with charisma. From his iconic role as Thomas Magnum in the television series "Magnum, P.I." to his enduring presence in "Blue Bloods," Selleck has captivated audiences with his versatility and charm. As a result, "Tom Selleck net worth" has become a topic of great interest among fans. and financial enthusiasts alike. This article delves deep into Tom Selleck's wealth, exploring his career, assets, endorsements. and business ventures that contribute to his impressive economic standing.
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Early Life and Career Beginnings
The Foundation of Tom Selleck's Wealth
Born on January 29, 1945, in Detroit, Michigan, Tom Selleck grew up in Sherman Oaks, California. His journey towards building a large net worth began with humble origins. , Selleck pursued a business administration degree at the University of Southern California (USC) on a basketball scholarship. But, his interest shifted towards acting. leading him to study at the Hills Playhouse under Milton Katselas.
Minor roles in television and films marked Selleck's early career. He appeared in commercials and took on small parts in T.V. series such as "The Dating Game" and "Lancer." These initial steps, although modest. laid the groundwork for his future success and the growth of Tom Selleck net worth. Breakthrough with "Magnum, P.I."
The Role that Defined Tom Selleck's Career
Tom Selleck's breakthrough came with the role of Thomas Magnum in the CBS television series "Magnum, P.I." (1980-1988). This role made him a household name and boosted his net worth. The series' popularity resulted in Selleck earning large salaries. leading to financial stability and increased recognition in Hollywood.
"Magnum P.I." garnered high ratings and critical acclaim during its run. Selleck's portrayal of the charming and resourceful private investigator resonated with audiences. making him one of the most beloved television actors of the 1980s. The success of "Magnum P.I." played a pivotal role in shaping Tom Selleck net worth, establishing him as a major star.
Film Career and Diversification
Expanding Tom Selleck's Financial Portfolio
While "Magnum, P.I." was a cornerstone of Selleck's career, he did not limit himself to television. He ventured into films, further enhancing Tom Selleck net worth. His filmography includes notable movies such as "Three Men and a Baby" (1987). which became the highest-grossing film of the year, and its sequel, "Three Men and a Little Lady" (1990). These box office successes contributed to his wealth.
Selleck's versatility allowed him to transition between genres. from comedies like "Mr. Baseball" (1992) to westerns such as "Quigley Down Under" (1990). This diversification showcased his acting range. and provided many income streams, reinforcing Tom Selleck net worth.
Television Resurgence with "Blue Bloods"
Sustaining Wealth through Consistent Success
In 2010, Tom Selleck began starring as Frank Reagan i
In the vast landscape of cinema, stories have been told, retold, and reimagined in countless ways. At the heart of this narrative evolution lies the concept of a "remake". A successful remake allows us to revisit cherished tales through a fresh lens, often reflecting a different era's perspective or harnessing the power of advanced technology. Yet, the question remains, what makes a remake successful? Today, we will delve deeper into this subject, identifying the key ingredients that contribute to the success of a remake.
Are the X-Men Marvel or DC An In-Depth Exploration.pdfXtreame HDTV
The world of comic books is vast and filled with iconic characters, gripping storylines, and legendary rivalries. Among the most famous groups of superheroes are the X-Men. Created in the early 1960s, the X-Men have become a cultural phenomenon, featuring in comics, animated series, and blockbuster movies. A common question among newcomers to the comic book world is: Are the X-Men Marvel or DC? This article delves into the history, creators, and significant moments of the X-Men to provide a comprehensive answer.
As a film director, I have always been awestruck by the magic of animation. Animation, a medium once considered solely for the amusement of children, has undergone a significant transformation over the years. Its evolution from a rudimentary form of entertainment to a sophisticated form of storytelling has stirred my creativity and expanded my vision, offering limitless possibilities in the realm of cinematic storytelling.
Panchayat Season 3 - Official Trailer.pdfSuleman Rana
The dearest series "Panchayat" is set to make a victorious return with its third season, and the fervor is discernible. The authority trailer, delivered on May 28, guarantees one more enamoring venture through the country heartland of India.
Jitendra Kumar keeps on sparkling as Abhishek Tripathi, the city-reared engineer who ends up functioning as the secretary of the Panchayat office in the curious town of Phulera. His nuanced depiction of a young fellow exploring the difficulties of country life while endeavoring to adjust to his new environmental factors has earned far and wide recognition.
Neena Gupta and Raghubir Yadav return as Manju Devi and Brij Bhushan Dubey, separately. Their dynamic science and immaculate acting rejuvenate the hardships of town administration. Gupta's depiction of the town Pradhan with an ever-evolving outlook, matched with Yadav's carefully prepared exhibition, adds profundity and credibility to the story.
New Difficulties and Experiences
The trailer indicates new difficulties anticipating the characters, as Abhishek keeps on wrestling with his part in the town and his yearnings for a superior future. The series has reliably offset humor with social editorial, and Season 3 looks ready to dig much more profound into the intricacies of rustic organization and self-awareness.
Watchers can hope to see a greater amount of the enchanting and particular residents who have become fan top picks. Their connections and the one of a kind cut of-life situations give a reviving and interesting portrayal of provincial India, featuring the two its appeal and its difficulties.
A Mix of Humor and Heart
One of the signs of "Panchayat" is its capacity to mix humor with sincere narrating. The trailer features minutes that guarantee to convey giggles, as well as scenes that pull at the heartstrings. This equilibrium has been a critical calculate the show's prosperity, resounding with crowds across different socioeconomics.
Creation Greatness
The creation quality remaining parts first rate, with the beautiful setting of Phulera town filling in as a scenery that upgrades the narrating. The meticulousness in portraying provincial life, joined with sharp composition and solid exhibitions, guarantees that "Panchayat" keeps on hanging out in the packed web series scene.
Expectation and Delivery
As the delivery date draws near, expectation for "Panchayat" Season 3 is at a record-breaking high. The authority trailer has previously created critical buzz, with fans enthusiastically anticipating the continuation of Abhishek Tripathi's excursion and the new undertakings that lie ahead in Phulera.
All in all, the authority trailer for "Panchayat" Season 3 recommends that watchers are in for another drawing in and engaging ride. Yet again with its charming characters, convincing story, and ideal mix of humor and show, the new season is set to enamor crowds. Write in your schedules and prepare to get back to the endearing universe of "Panchayat."
From the Editor's Desk: 115th Father's day Celebration - When we see Father's day in Hindu context, Nanda Baba is the most vivid figure which comes to the mind. Nanda Baba who was the foster father of Lord Krishna is known to provide love, care and affection to Lord Krishna and Balarama along with his wife Yashoda; Letter’s to the Editor: Mother's Day - Mother is a precious life for their children. Mother is life breath for her children. Mother's lap is the world happiness whose debt can never be paid.
Scandal! Teasers June 2024 on etv Forum.co.zaIsaac More
Monday, 3 June 2024
Episode 47
A friend is compelled to expose a manipulative scheme to prevent another from making a grave mistake. In a frantic bid to save Jojo, Phakamile agrees to a meeting that unbeknownst to her, will seal her fate.
Tuesday, 4 June 2024
Episode 48
A mother, with her son's best interests at heart, finds him unready to heed her advice. Motshabi finds herself in an unmanageable situation, sinking fast like in quicksand.
Wednesday, 5 June 2024
Episode 49
A woman fabricates a diabolical lie to cover up an indiscretion. Overwhelmed by guilt, she makes a spontaneous confession that could be devastating to another heart.
Thursday, 6 June 2024
Episode 50
Linda unwittingly discloses damning information. Nhlamulo and Vuvu try to guide their friend towards the right decision.
Friday, 7 June 2024
Episode 51
Jojo's life continues to spiral out of control. Dintle weaves a web of lies to conceal that she is not as successful as everyone believes.
Monday, 10 June 2024
Episode 52
A heated confrontation between lovers leads to a devastating admission of guilt. Dintle's desperation takes a new turn, leaving her with dwindling options.
Tuesday, 11 June 2024
Episode 53
Unable to resort to violence, Taps issues a verbal threat, leaving Mdala unsettled. A sister must explain her life choices to regain her brother's trust.
Wednesday, 12 June 2024
Episode 54
Winnie makes a very troubling discovery. Taps follows through on his threat, leaving a woman reeling. Layla, oblivious to the truth, offers an incentive.
Thursday, 13 June 2024
Episode 55
A nosy relative arrives just in time to thwart a man's fatal decision. Dintle manipulates Khanyi to tug at Mo's heartstrings and get what she wants.
Friday, 14 June 2024
Episode 56
Tlhogi is shocked by Mdala's reaction following the revelation of their indiscretion. Jojo is in disbelief when the punishment for his crime is revealed.
Monday, 17 June 2024
Episode 57
A woman reprimands another to stay in her lane, leading to a damning revelation. A man decides to leave his broken life behind.
Tuesday, 18 June 2024
Episode 58
Nhlamulo learns that due to his actions, his worst fears have come true. Caiphus' extravagant promises to suppliers get him into trouble with Ndu.
Wednesday, 19 June 2024
Episode 59
A woman manages to kill two birds with one stone. Business doom looms over Chillax. A sobering incident makes a woman realize how far she's fallen.
Thursday, 20 June 2024
Episode 60
Taps' offer to help Nhlamulo comes with hidden motives. Caiphus' new ideas for Chillax have MaHilda excited. A blast from the past recognizes Dintle, not for her newfound fame.
Friday, 21 June 2024
Episode 61
Taps is hungry for revenge and finds a rope to hang Mdala with. Chillax's new job opportunity elicits mixed reactions from the public. Roommates' initial meeting starts off on the wrong foot.
Monday, 24 June 2024
Episode 62
Taps seizes new information and recruits someone on the inside. Mary's new job
1. WHAT IS CAPITAL BUDGETING?
Capital budgeting is a required managerial tool. One duty of a financial manager is to choose
investments with satisfactory cash flows and rates of return. Therefore, a financial manager must
be able to decide whether an investment is worth undertaking and be able to choose intelligently
between two or more alternatives. To do this, a sound procedure to evaluate, compare, and select
projects is needed. This procedure is called capital budgeting.
I. CAPITAL IS A LIMITED RESOURCE
In the form of either debt or equity, capital is a very limited resource. There is a limit to the
volume of credit that the banking system can create in the economy. Commercial banks and
other lending institutions have limited deposits from which they can lend money to individuals,
corporations, and governments. In addition, the Federal Reserve System requires each bank to
maintain part of its deposits as reserves. Having limited resources to lend, lending institutions
are selective in extending loans to their customers. But even if a bank were to extend unlimited
loans to a company, the management of that company would need to consider the impact that
increasing loans would have on the overall cost of financing.
In reality, any firm has limited borrowing resources that should be allocated among the best
investment alternatives. One might argue that a company can issue an almost unlimited amount
of common stock to raise capital. Increasing the number of shares of company stock, however,
will serve only to distribute the same amount of equity among a greater number of shareholders.
In other words, as the number of shares of a company increases, the company ownership of the
individual stockholder may proportionally decrease.
The argument that capital is a limited resource is true of any form of capital, whether debt or
equity (short-term or long-term, common stock) or retained earnings, accounts payable or notes
payable, and so on. Even the best-known firm in an industry or a community can increase its
borrowing up to a certain limit. Once this point has been reached, the firm will either be denied
more credit or be charged a higher interest rate, making borrowing a less desirable way to raise
capital.
Faced with limited sources of capital, management should carefully decide whether a
particular project is economically acceptable. In the case of more than one project, management
must identify the projects that will contribute most to profits and, consequently, to the value (or
wealth) of the firm. This, in essence, is the basis of capital budgeting.
YOU SHOULD REMEMBER
Capital budgeting is investment decision-making as to whether a project is worth
undertaking. Capital budgeting is basically concerned with the justification of capital
expenditures.
Current expenditures are short-term and are completely written off in the same year that
expenses occur. Capital expenditures are long-term and are amortized over a period of
years are required by the IRS.
2. II. Basic Steps of Capital Budgeting
1. Estimate the cash flows
2. Assess the riskiness of the cash flows.
3. Determine the appropriate discount rate.
4. Find the PV of the expected cash flows.
5. Accept the project if PV of inflows > costs.
IRR > Hurdle Rate and/or
payback < policy
Definitions:
Independent versus mutually exclusive
projects.
Normal versus non-normal projects.
Basic Data
Expected Net Cash Flow
Year Project L Project S
0
1
2
3
($100)
10
60
80
($100)
70
50
20
III. Evaluation Techniques
A. Payback period
B. Net present value (NPV)
C. Internal rate of return (IRR)
D. Modified internal rate of return
(MIRR)
E. Profitability index
3. A. PAYBACK PERIOD
Payback period = Expected number of years
required to recover a project’s cost.
Project L
Expected Net Cash Flow
Year Project L Project S
0
1
2
3
($100)
10
60
80
($100)
(90)
(30)
50
PaybackL = 2 + $30/$80 years
= 2.4 years.
PaybackS = 1.6 years.
Weaknesses of Payback:
1. Ignores the time value of money. This
weakness is eliminated with the discounted
payback method.
2. Ignores cash flows occurring after the
payback period.
B. NET PRESENT VALUE
∑
= +
=
n
0t tk)(1
tCF
NPV
Project L:
9.09
49.59
60.11
NPVL = $ 18.79
NPVS = $19.98
If the projects are independent, accept both.
If the projects are mutually exclusive, accept
Project S since NPVS > NPVL.
0 1 2 3
−100.00 10 60 80
4. Note: NPV declines as k increases, and NPV
rises as k decreases.
C. INTERNAL RATE OF RETURN
( )
NPV$0
n
0t tIRR1
tCF
:IRR ==∑
= +
.
Project L:
8.47
43.02
48.57
$ 0.06 ≈ $0
IRRL = 18.1%
IRRS = 23.6%
If the projects are independent, accept both
because IRR > k.
If the projects are mutually exclusive, accept
Project S since IRRS > IRRL.
Note: IRR is independent of the cost of
capital.
0 1 2 3
−100.00 10 60 80
18.1%
18.1%
18.1%
k NPVL NPVS
0%
5
10
15
20
$50
33
19
7
(4)
$40
29
20
12
5
50
40
30
20
10
0
-10
5 10 15 20 25 k(%)
Crossover Point = 8.7%
IRRS = 23.6%
IRRL = 18.1%
NPV
($)
5. 1. ADVANTAGES AND DISADVANTAGES OF IRR AND NPV
A number of surveys have shown that, in practice, the IRR method is more popular than the NPV
approach. The reason may be that the IRR is straightforward, but it uses cash flows and
recognizes the time value of money, like the NPV. In other words, while the IRR method is easy
and understandable, it does not have the drawbacks of the ARR and the payback period, both of
which ignore the time value of money.
The main problem with the IRR method is that it often gives unrealistic rates of return.
Suppose the cutoff rate is 11% and the IRR is calculated as 40%. Does this mean that the
management should immediately accept the project because its IRR is 40%. The answer is no!
An IRR of 40% assumes that a firm has the opportunity to reinvest future cash flows at 40%. If
past experience and the economy indicate that 40% is an unrealistic rate for future reinvestments,
an IRR of 40% is suspect. Simply speaking, an IRR of 40% is too good to be true! So unless the
calculated IRR is a reasonable rate for reinvestment of future cash flows, it should not be used as
a yardstick to accept or reject a project.
Another problem with the IRR method is that it may give different rates of return. Suppose
there are two discount rates (two IRRs) that make the present value equal to the initial
investment. In this case, which rate should be used for comparison with the cutoff rate? The
purpose of this question is not to resolve the cases where there are different IRRs. The purpose
is to let you know that the IRR method, despite its popularity in the business world, entails more
problems than a practitioner may think.
2. WHY THE NPV AND IRR SOMETIMES SELECT DIFFERENT PROJECTS
When comparing two projects, the use of the NPV and the IRR methods may give different
results. A project selected according to the NPV may be rejected if the IRR method is used.
Suppose there are two alternative projects, X and Y. The initial investment in each project is
$2,500. Project X will provide annual cash flows of $500 for the next 10 years. Project Y has
annual cash flows of $100, $200, $300, $400, $500, $600, $700, $800, $900, and $1,000 in the
same period. Using the trial and error method explained before, you find that the IRR of Project
X is 17% and the IRR of Project Y is around 13%. If you use the IRR, Project X should be
preferred because its IRR is 4% more than the IRR of Project Y. But what happens to your
decision if the NPV method is used? The answer is that the decision will change depending on
the discount rate you use. For instance, at a 5% discount rate, Project Y has a higher NPV than
X does. But at a discount rate of 8%, Project X is preferred because of a higher NPV.
The purpose of this numerical example is to illustrate an important distinction: The use of
the IRR always leads to the selection of the same project, whereas project selection using the
NPV method depends on the discount rate chosen.
6. • PROJECT SIZE AND LIFE
There are reasons why the NPV and the IRR are sometimes in conflict: the size and life of the
project being studied are the most common ones. A 10-year project with an initial investment of
$100,000 can hardly be compared with a small 3-year project costing $10,000. Actually, the
large project could be thought of as ten small projects. So if you insist on using the IRR and the
NPV methods to compare a big, long-term project with a small, short-term project, don’t be
surprised if you get different selection results. (See the equivalent annual annuity discussed later
for a good way to compare projects with unequal lives.)
• DIFFERENT CASH FLOWS
Furthermore, even two projects of the same length may have different patterns of cash flow. The
cash flow of one project may continuously increase over time, while the cash flows of the other
project may increase, decrease, stop, or become negative. These two projects have completely
different forms of cash flow, and if the discount rate is changed when using the NPV approach,
the result will probably be different orders of ranking. For example, at 10% the NPV of Project
A may be higher than that of Project B. As soon as you change the discount rate to 15%, Project
B may be more attractive.
WHEN ARE THE NPV AND IRR RELIABLE?
Generally speaking, you can use and rely on both the NPV and the IRR if two conditions are
met. First, if projects are compared using the NPV, a discount rate that fairly reflects the risk of
each project should be chosen. There is no problem if two projects are discounted at two
different rates because one project is riskier than the other. Remember that the result of the NPV
is as reliable as the discount rate that is chosen. If the discount rate is unrealistic, the decision to
accept or reject the project is baseless and unreliable. Second, if the IRR method is used, the
project must not be accepted only because its IRR is very high. Management must ask whether
such an impressive IRR is possible to maintain. In other words, management should look into
past records, and existing and future business, to see whether an opportunity to reinvest cash
flows at such a high IRR really exists. If the firm is convinced that such an IRR is realistic, the
project is acceptable. Otherwise, the project must be reevaluated by the NPV method, using a
more realistic discount rate.
D.
YOU SHOULD REMEMBER
The internal rate of return (IRR) is a popular method in capital budgeting. The IRR is a
discount rate that makes the present value of estimated cash flows equal to the initial
investment. However, when using the IRR, you should make sure that the calculated IRR is
not very different from a realistic reinvestment rate.
7. Modified IRR (MIRR)
The MIRR is similar to the IRR, but is theoretically superior in that it
overcomes two weaknesses of the IRR. The MIRR correctly assumes reinvestment
at the project’s cost of capital and avoids the problem of multiple IRRs. However,
please note that the MIRR is not used as widely as the IRR in practice.
There are 3 basic steps of the MIRR:
(1) Estimate all cash flows as in IRR.
(2) Calculate the future value of all cash inflows at the last year of the project’s
life.
(3) Determine the discount rate that causes the future value of all cash inflows
determined in step 2, to be equal to the firm’s investment at time zero. This
discount rate is known as the MIRR.
Project L:
MIRRL = 16.5%.
MIRR is better than IRR because
1. MIRR correctly assumes reinvestment at project’s cost of capital.
2. MIRR avoids the problem of multiple IRRs.
0 1 2 3
-100.00 10 60 80.00
66.00
12.10
$158.10 = TV of
inflows
100.00
$ 0.00 = NPV
PV outflows = $100
TV inflows = $158.10.
PVcosts =
10%
MIRR = 16.5%
8. E. PROFITABILITY INDEX (PI)
The profitability index, or PI, method compares the present value of future cash
inflows with the initial investment on a relative basis. Therefore, the PI is the ratio
of the present value of cash flows (PVCF) to the initial investment of the project.
investmentInitial
PVCF
PI =
In this method, a project with a PI greater than 1 is accepted, but a project is
rejected when its PI is less than 1. Note that the PI method is closely related to the
NPV approach. In fact, if the net present value of a project is positive, the PI will
be greater than 1. On the other hand, if the net present value is negative, the
project will have a PI of less than 1. The same conclusion is reached, therefore,
whether the net present value or the PI is used. In other words, if the present value
of cash flows exceeds the initial investment, there is a positive net present value
and a PI greater than 1, indicating that the project is acceptable.
PI is also known as a benefit/cash ratio.
Project L
costinitial
flowscashofPV
PI =
19.1
100
79.118
==
Accept project if PI > 1.0
Reject if PI < 1.0
0 1 2 3
-100.00 10 60 80
PV1 9.09
PV2 49.59
PV3 60.11
118.79
10%
9. F. EQUIVALENT ANNUAL ANNUITY
What do you do when project lives vary significantly? An easy and intuitively
appealing approach is to compare the “equivalent annual annuity” among all the
projects. The equivalent annuity is the level annual payment across a project’s
specific life that has a present value equal to that of another cash-flow stream.
Projects of equal size but different life can be ranked directly by their equivalent
annuity. This approach is also known as equivalent annual cost, equivalent annual
cash flow, or simply equivalent annuity approach. The equivalent annual annuity
is solved for by this equation:
Equivalent Annuity = PV(Cash Flows) / (present value factor of n-year annuity)
10. IV. PROJECT DECISION ANALYSIS
A. MAKING GO/NO-GO PROJECT DECISION
(Suggestions by R. Bruner)
Virtually all general managers face capital-budgeting decisions in the course of their
careers. The most common of these is the simple “yes” versus “no” choice about a
capital investment. The following are some general guidelines to orient the decision
maker in these situations.
1. Focus on cash flows, not profits. One wants to get as close as possible to the
economic reality of the project. Accounting profits contain many kinds of economic
fiction. Flows of cash, on the other hand, are economic facts.
2. Focus on incremental cash flows. The point of the whole analytical exercise is to
judge whether the firm will be better off or worse off if it undertakes the project.
Thus one wants to focus on the changes in cash flows effected by the project. The
analysis may require some careful thought: a project decision identified as a simple
go/no-go question may hide a subtle substitution or choice among alternatives. For
instance, a proposal to invest in an automated machine should trigger many
questions: Will the machine expand capacity (and thus permit us to exploit demand
beyond our current limits)? Will the machine reduce costs (at the current level of
demand) and thus permit us to operate more efficiently than before we had the
machine? Will the machine create other benefits (e.g., higher quality, more
operational flexibility)? The key economic question asked of project proposals
should be, “How will things change (i.e., be better or worse) if we undertake the
project?”
3. Account for time. Time is money. We prefer to receive cash sooner rather than
later. Use NPV as the technique to summarize the quantitative attractiveness of the
project. Quite simply, NPV can be interpreted as the amount by which the market
value of the firm’s equity will change as a result of undertaking the project.
4. Account for risk. Not all projects present the same level or risk. One wants to be
compensated with a higher return for taking more risk. The way to control for
variations in risk from project to project is to use a discount rate to value a flow of
cash that is consistent with the risk of that flow.
These 4 precepts summarize a great amount of economic theory that has stood the
test of time. Organizations using these precepts make better investment decisions than
organizations that do not use these precepts.
11. B. THE PROCESS OF PROJECT EVALUATION
(Suggestions by R. Bruner)
1. Carefully estimate expected future cash flows.
2. Select a discount rate consistent with the risk of those future cash flows.
3. Compute a “base-case” NPV.
4. Identify risks and uncertainties. Run a sensitivity analysis.
Identify “key value drivers”.
Identify break-even assumptions.
Estimate scenario values.
Bound the range of value.
5. Identify qualitative issues.
Flexibility
Quality
Know-how
Learning
6. Decide
12. C. CAPITAL RATIONING
(Suggestions by R. Bruner)
• Exists whenever enterprises cannot, or choose not to, accept all value-creating investment
projects. Possible causes:
Banks and investors say “NO”
Managerial conservatism
• Analysis is required. One must consider sets of projects, or “bundles”, rather than
individual projects. The goal should be to identify the value-maximizing bundle of
projects.
• The danger is that the capital-rationing constraint heightens the influence of nonfinancial
considerations, such as the following:
Competition among alternative strategies
Corporate politics
Bargaining games and psychology
The outcome could be a sub-optimal capital budget, or, worse, one that destroys value!
• Some remedies are the following:
Relax and eliminate the budget constraint.
Manage the process rather than the outcomes.
Develop a corporate culture committed to value creation.
Reference: http://www.exinfm.com/training/s_course_desc.html