The document provides information and examples to analyze two potential acquisition choices, Corporation A and Corporation B, using various capital budgeting tools. Key data on revenues, expenses, and cash flows for each corporation over a 5-year period is given. The analysis is to be done in a Microsoft Excel spreadsheet calculating the net present value, internal rate of return, modified internal rate of return, profitability index, payback period, and discounted payback period for each choice and determining which provides the best return based on these metrics. Examples of calculating some of these metrics are also provided.
Project Analysis And Valuation - Introduction To Project Analysis And ValuationASAD ALI
Valuation analysis is used to evaluate the potential merits of an investment or to objectively assess the value of a business or asset. Valuation analysis is one of the core duties of a fundamental investor, as valuations (along with cash flows) are typically the most important drivers of asset prices over the long term.
1. Payback Period and Net Present Value[LO1, 2] If a project with .docxpaynetawnya
1. Payback Period and Net Present Value[LO1, 2] If a project with conventional cash flows has a payback period less than the project’s life, can you definitively state the algebraic sign of the NPV? Why or why not? If you know that the discounted payback period is less than the project’s life, what can you say about the NPV? Explain.
Internal Rate of Return[LO5] Concerning IRR:
a. Describe how the IRR is calculated, and describe the information this measure provides about a sequence of cash flows. What is the IRR criterion decision rule?
b. What is the relationship between IRR and NPV? Are there any situations in which you might prefer one method over the other? Explain.
c. Despite its shortcomings in some situations, why do most financial managers use IRR along with NPV when evaluating projects? Can you think of a situation in which IRR might be a more appropriate measure to use than NPV? Explain.
14. Net Present Value[LO1] It is sometimes stated that “the net present value approach assumes reinvestment of the intermediate cash flows at the required return.” Is this claim correct? To answer, suppose you calculate the NPV of a project in the usual way. Next, suppose you do the following:
a. Calculate the future value (as of the end of the project) of all the cash flows other than the initial outlay assuming they are reinvested at the required return, producing a single future value figure for the project.
b. Calculate the NPV of the project using the single future value calculated in the previous step and the initial outlay. It is easy to verify that you will get the same NPV as in your original calculation only if you use the required return as the reinvestment rate in the previous step.
17. Comparing Investment Criteria Consider the following two mutually exclusive projects:
Year Cash Flow (A) Cash Flow (B)
If you apply the payback criterion, which investment will you choose? Why?
b. If you apply the discounted payback criterion, which investment will you choose? Why?
c. If you apply the NPV criterion, which investment will you choose? Why?
d. If you apply the IRR criterion, which investment will you choose? Why?
e. If you apply the profitability index criterion, which investment will you choose? Why?
5. Equivalent Annual Cost [LO4]
1. When is EAC analysis appropriate for comparing two or more projects?
2. Why is this method used?
3 .Are there any implicit assumptions required by this method that you find troubling? Explain.
6. Cash Flow and Depreciation [LO1] “When evaluating projects, we’re concerned with only the relevant incremental after tax cash flows. Therefore, because depreciation is a noncash expense, we should ignore its effects when evaluating projects.” Critically evaluate this statement.
QUESTION AND PROBLEMS
1. Relevant Cash Flows [LO1] Parker & Stone, Inc., is looking at setting up a new manufacturing plant in South Park to produce garden tools. The company bought some land six years ago for $5 ...
Project Analysis And Valuation - Introduction To Project Analysis And ValuationASAD ALI
Valuation analysis is used to evaluate the potential merits of an investment or to objectively assess the value of a business or asset. Valuation analysis is one of the core duties of a fundamental investor, as valuations (along with cash flows) are typically the most important drivers of asset prices over the long term.
1. Payback Period and Net Present Value[LO1, 2] If a project with .docxpaynetawnya
1. Payback Period and Net Present Value[LO1, 2] If a project with conventional cash flows has a payback period less than the project’s life, can you definitively state the algebraic sign of the NPV? Why or why not? If you know that the discounted payback period is less than the project’s life, what can you say about the NPV? Explain.
Internal Rate of Return[LO5] Concerning IRR:
a. Describe how the IRR is calculated, and describe the information this measure provides about a sequence of cash flows. What is the IRR criterion decision rule?
b. What is the relationship between IRR and NPV? Are there any situations in which you might prefer one method over the other? Explain.
c. Despite its shortcomings in some situations, why do most financial managers use IRR along with NPV when evaluating projects? Can you think of a situation in which IRR might be a more appropriate measure to use than NPV? Explain.
14. Net Present Value[LO1] It is sometimes stated that “the net present value approach assumes reinvestment of the intermediate cash flows at the required return.” Is this claim correct? To answer, suppose you calculate the NPV of a project in the usual way. Next, suppose you do the following:
a. Calculate the future value (as of the end of the project) of all the cash flows other than the initial outlay assuming they are reinvested at the required return, producing a single future value figure for the project.
b. Calculate the NPV of the project using the single future value calculated in the previous step and the initial outlay. It is easy to verify that you will get the same NPV as in your original calculation only if you use the required return as the reinvestment rate in the previous step.
17. Comparing Investment Criteria Consider the following two mutually exclusive projects:
Year Cash Flow (A) Cash Flow (B)
If you apply the payback criterion, which investment will you choose? Why?
b. If you apply the discounted payback criterion, which investment will you choose? Why?
c. If you apply the NPV criterion, which investment will you choose? Why?
d. If you apply the IRR criterion, which investment will you choose? Why?
e. If you apply the profitability index criterion, which investment will you choose? Why?
5. Equivalent Annual Cost [LO4]
1. When is EAC analysis appropriate for comparing two or more projects?
2. Why is this method used?
3 .Are there any implicit assumptions required by this method that you find troubling? Explain.
6. Cash Flow and Depreciation [LO1] “When evaluating projects, we’re concerned with only the relevant incremental after tax cash flows. Therefore, because depreciation is a noncash expense, we should ignore its effects when evaluating projects.” Critically evaluate this statement.
QUESTION AND PROBLEMS
1. Relevant Cash Flows [LO1] Parker & Stone, Inc., is looking at setting up a new manufacturing plant in South Park to produce garden tools. The company bought some land six years ago for $5 ...
hiExplain what is Hadoop, how its fit into the Data Wareho.docxjeniihykdevara
hi
Explain what is
Hadoop
, how its fit into the Data Warehouse creation/utilization concept, what advantages its bring over the earlier and more traditional DW back-end technologies, and any other material on these topic that you find interesting.
write two paragraphs about that.
.
Hide Folder InformationThis project is due in about 3 12 hour.docxjeniihykdevara
Hide Folder Information
This project is due in about 3 1/2 hours, I submitted the wrong one yesterday (will still pay the service) but need THIS one accomplished soon. Any takers?
Digital media has changed the ways ideas, information, and arguments in society are communicated both locally and globally. Individuals and organizations frequently use digital media as a means to influence individuals and organizations.
Students are required to identify a specific company, organization, or individual and demonstrate how digital media has been used to influence or change its core business processes. You will then create a presentation (using an application like PowerPoint) which interprets and analyzes how the messages within the digital media were used to guide decision-making.
Formatting Requirements
Project must follow APA style
Footers including slide numbers, student name, and project name
File name first initial, last name and project (ex. BWright_presentation)
Minimum of 15 slides, maximum 20 slides (excluding title slide and bibliographical slide)
Use of tables, graphs, images, etc. of appropriate size that are relevant to the information being conveyed is highly encouraged.
Title slide to include:
Your name
Instructor name
Course name and number
Project title
Content Requirements
Introduction and Synopsis of Company, Organization or Individual.
Influence on or change to Organization and/or Individual
Analysis of How Digital Media Guided Decision Making
Conclusion and Analysis of Results of Change
Bibliographical slide with minimum of 2 professional / scholarly sources. Wikipedia is not acceptable.
Keep in mind the 7 x 7 rule with presentation software, which effectively states no more than 7 words per bullet and 7 bullets per slide. This something to keep in mind to assist in effectively communicating information and not a specific requirement of the project.
Complete and submit your project no later than 11:59PM (ET) on 02/14/2016.
.
Hi, i have a draft of my paper about technology need to be fina.docxjeniihykdevara
Hi,
i have a draft of my paper about technology need to be finalized.
It has 3 1/2 pages to 4 pages now, and need to be finalized to 5-6 pages. it is about technology.
i am a freshmen and international student, so no fancy words needed. just make it general.
i need it tmr afternoon.
if i want to make the deal with you, i will send you my draft by email.
thx
.
Hi,Write a narrative essay.The topic for this essay Write a.docxjeniihykdevara
Hi,
Write a narrative essay.
The topic for this essay: Write an essay in which you use narration and description to recreate a time and place when you felt like an outsider or felt threatened in some way. Make sure to show the reader what you learned from this experience.
I attached the outline.
.
Hi,The paper is Masters degree level. Must be written in APA styl.docxjeniihykdevara
Hi,
The paper is Master's degree level. Must be written in APA style and is 10 pages in length. I have the resources lis to use but please only respond if you have access to EBSCO or I will not hire you. The paper looks at a fictitious case study and then you are to write an evaluation plan, a group level and individual level intervention plan. More details in email when I choose soemone. Thanks.
.
More Related Content
Similar to HelloI need the below assignment by 28 Feb 16 by 4 Pm eastern ti.docx
hiExplain what is Hadoop, how its fit into the Data Wareho.docxjeniihykdevara
hi
Explain what is
Hadoop
, how its fit into the Data Warehouse creation/utilization concept, what advantages its bring over the earlier and more traditional DW back-end technologies, and any other material on these topic that you find interesting.
write two paragraphs about that.
.
Hide Folder InformationThis project is due in about 3 12 hour.docxjeniihykdevara
Hide Folder Information
This project is due in about 3 1/2 hours, I submitted the wrong one yesterday (will still pay the service) but need THIS one accomplished soon. Any takers?
Digital media has changed the ways ideas, information, and arguments in society are communicated both locally and globally. Individuals and organizations frequently use digital media as a means to influence individuals and organizations.
Students are required to identify a specific company, organization, or individual and demonstrate how digital media has been used to influence or change its core business processes. You will then create a presentation (using an application like PowerPoint) which interprets and analyzes how the messages within the digital media were used to guide decision-making.
Formatting Requirements
Project must follow APA style
Footers including slide numbers, student name, and project name
File name first initial, last name and project (ex. BWright_presentation)
Minimum of 15 slides, maximum 20 slides (excluding title slide and bibliographical slide)
Use of tables, graphs, images, etc. of appropriate size that are relevant to the information being conveyed is highly encouraged.
Title slide to include:
Your name
Instructor name
Course name and number
Project title
Content Requirements
Introduction and Synopsis of Company, Organization or Individual.
Influence on or change to Organization and/or Individual
Analysis of How Digital Media Guided Decision Making
Conclusion and Analysis of Results of Change
Bibliographical slide with minimum of 2 professional / scholarly sources. Wikipedia is not acceptable.
Keep in mind the 7 x 7 rule with presentation software, which effectively states no more than 7 words per bullet and 7 bullets per slide. This something to keep in mind to assist in effectively communicating information and not a specific requirement of the project.
Complete and submit your project no later than 11:59PM (ET) on 02/14/2016.
.
Hi, i have a draft of my paper about technology need to be fina.docxjeniihykdevara
Hi,
i have a draft of my paper about technology need to be finalized.
It has 3 1/2 pages to 4 pages now, and need to be finalized to 5-6 pages. it is about technology.
i am a freshmen and international student, so no fancy words needed. just make it general.
i need it tmr afternoon.
if i want to make the deal with you, i will send you my draft by email.
thx
.
Hi,Write a narrative essay.The topic for this essay Write a.docxjeniihykdevara
Hi,
Write a narrative essay.
The topic for this essay: Write an essay in which you use narration and description to recreate a time and place when you felt like an outsider or felt threatened in some way. Make sure to show the reader what you learned from this experience.
I attached the outline.
.
Hi,The paper is Masters degree level. Must be written in APA styl.docxjeniihykdevara
Hi,
The paper is Master's degree level. Must be written in APA style and is 10 pages in length. I have the resources lis to use but please only respond if you have access to EBSCO or I will not hire you. The paper looks at a fictitious case study and then you are to write an evaluation plan, a group level and individual level intervention plan. More details in email when I choose soemone. Thanks.
.
High and Low Context CommunicationResearch high and low context co.docxjeniihykdevara
High and Low Context Communication
Research high and low context communication. High and low context communication is a style of communication that caters to people in groups that have similar experiences and expectations.
Many things are left unsaid in this style of communication and the context of the message is filled in by the person’s understanding of the culture.
It is reasonable to assume that most police officers use this style of communication within their communities.
Determine how this could be a problem in communication between a police officer and a person who speaks English as a second language and in a 2-3 page paper in APA formatting describe how police officers can be trained to deal with this situation.
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Hi,Please answer all three questions below, also attached textbook.docxjeniihykdevara
Hi,
Please answer all three questions below, also attached textbook for references.
1. What challenges or opportunities will social media present in reaching during disasters, unique populations such as non-English speakers or individuals with disabilities?
2. How do consumers of social media messages distinguish credible from less credible information? How can emergency managers create and disseminate messages that have high credibility?
3. What are the special characteristics of the emergency management community that limit the adoption social media?
Note:
·
Have at least 2 References (you can have more than two references)
·
Have at least 500 words (you can exceed 500 words)
·
Double-spaced
·
Font size 12
Please, I will appreciate it if you can send me the answers on Friday (December 4, 2015) by 6:30 pm. Thanks
Best regards...Owanaba
.
Hi,Please find attached the article and answer the question below.docxjeniihykdevara
Hi,
Please find attached the article and answer the question below:
Based on your understanding of the assigned reading in Chap2, answer the following two essay
questions:
1. Why is social media important to the future of emergency management?
2. Should the emergency management community utilize current social media systems for the development of these technologies or create new systems like the First Responder
Communities of Practice?
Notes:
·
2 pages (max)
·
Double-spaced
·
Font size 12
Please I will appreciate it if you can send me the answers tomorrow by 18:45(6:45pm). Thanks
Best regards...Owanaba
.
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Hi,
I want a report about the uploaded case study. These are the questions.
Questions:
1. Russia’s transition to capitalism did not go as planned. What went wrong?
2. Who is to blame?
3. What is to be done?
Note that each question should be answered seperately.
The instructions are:-
1-The paper should be 11 pages.
2-Only 5 writing pages and the other 6 mostly exhibits (Charts)
3-The Exhibits can be from the internet but mostly referred to in answering the questions.
4-The font is 12 double spaced.
5-The Citation scale is APA.
6-The case study should be the main resource and you can use two additional resources.
.
Hi,I need someone to implement my paper in part of1.result&discu.docxjeniihykdevara
Hi,
I need someone to implement my paper in part of
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2. conclusion
3. add technical terms
4. some appendix
5. add more references
Paper in topic: Non-Human Factors Analysis of Aviation Accident Focus on Machine Failure.
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I have a book discussion in my literature class, the book is Look back in anger by john osborne. I have uploaded an attachment with instructions for the discussion. there will be 2 topics, choose one of them and work on it . I'm gonna need examples and page numbers for the examples.
so please look at the attachment and let me know if you need more info.
best
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Hi,I got two summaries. Each summary is ONE PAGE.The first.docxjeniihykdevara
Hi,
I got two summaries.
Each summary is ONE PAGE.
The first one is a summary of the article "The inside and the outside" attached here.
The second one is a summary of the first two pages of "The politics of the derestoration" ONYL THE FIRST TWO PAGES. Skip the first page that has the conditions, start from the page where the article starts.
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Hi, I need this assingment by tomorrow 12415 at 1159PM. I hav.docxjeniihykdevara
Hi, I need this assingment by tomorrow
12/4/15 at 11:59PM
. I have included the article in the attachments as well as the instructions. It needs to be around 100 words or more and any sources need to be cited. Many thanks in advance!
Review the Means and Olarte article, "Today's Trends in Capital Financing" from the unit studies and consider the following questions and post your response:
What are the major trends in health care finance?
How will these major trends affect the provision of quality services?
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Hi, I need this discussion question answered by 1159pm tomorrow Fri.docxjeniihykdevara
Hi, I need this discussion question answered by 11:59pm tomorrow Friday 7/17/15. I have posted the question and guidlines below. Thanks so much!
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Review the definitions of Kantianism, Utilitarianism, Liberal Individualism, and Communitarianism. Describe a real-life example for each of them, from both personal and a career perspectives
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Hi,I have three article, what I need is a one page summary of a .docxjeniihykdevara
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I have three article, what I need is a one page summary of a short section of each article.
I have the sections names so what you gotta do is summarizing the section not the whole articles.
1-The first article is "Feldman_ArtB_INtercultural" and the required section is "Royal Diplomacy and the International Concept of Kingship" on page 19.
2-The econd article is "Linzey_Imhotep" and the required section is "The Pyramid Texts".
3-The third article is "Pittman_1996" and the required section is "The Gebel el-Arak" on page3
YOU HAVE 4 HOURS!!
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Hi, I need help writing an art history paper wondering if you could .docxjeniihykdevara
Hi, I need help writing an art history paper wondering if you could help. I have chose to write about living artist Richard Serra. In the paper I need to include his collections and exhibitions as well as how his work relates to installation art and other artists work such as: Ilya Kabakov and his work of
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Hi, I need help with my papers but I need someone with experience in.docxjeniihykdevara
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Hi, I have an assignment in my religion class, I have uploaded the i.docxjeniihykdevara
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this is the topic of the paper , please look at everything cerfully and let me know if you can do it.
Reflection 2:
Based on at least one of the definitions of religion and nature we’ve discussed over the last
two weeks, is it valid to think of environmentalism as a religion, as suggested by Thomas
Dunlap? Explain your reasoning, being sure to consider multiple possible answers in
addition to defending your own.
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the case study is : MediSys Corp.: The IntensCare Product Development Team.
we use a book in class called Robbins,Organizational Behavior, 16th edition S. P. & Judge, T. A. (2015).
There will be a Related Reading in Ch. 9 Foundations of Group Behavior,and Ch. 10.Understanding Work Teams.
I will upload an attchment descriping the requirment of the assignment. Thank you
Please let me know if you need more info.
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The people of Punjab felt alienated from main stream due to denial of their just demands during a long democratic struggle since independence. As it happen all over the word, it led to militant struggle with great loss of lives of military, police and civilian personnel. Killing of Indira Gandhi and massacre of innocent Sikhs in Delhi and other India cities was also associated with this movement.
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Ethnobotany and Ethnopharmacology:
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HelloI need the below assignment by 28 Feb 16 by 4 Pm eastern ti.docx
1. Hello
I need the below assignment by 28 Feb 16 by 4 Pm eastern time
Your company is thinking about acquiring another corporation.
You have two choices
—
the cost of each choice is $250,000. You cannot spend more
than that, so acquiring both corporations is not an option. The
following are your critical data:
Corporation A
Revenues = $100,000 in year one, increasing by 10% each year
Expenses = $20,000 in year one, increasing by 15% each year
Depreciation expense = $5,000 each year
Tax rate = 25%
Discount rate = 10%
Corporation B
Revenues = $150,000 in year one, increasing by 8% each year
Expenses = $60,000 in year one, increasing by 10% each year
Depreciation expense = $10,000 each year
Tax rate = 25%
Discount rate = 11%
Compute and analyze items (a) through (d) using a Microsoft
®
Excel
®
spreadsheet. Make sure all calculations can be seen in the
background of the applicable spreadsheet cells. In other words,
leave an audit trail so others can see how you arrived at your
calculations and analysis. Items (a) through (d) should be
submitted in Microsoft
2. ®
Excel
®
; indicate your recommendation (e) in the Microsoft
®
Excel
®
spreadsheet;
the paper stated in item (f) should be submitted consistent with
APA guidelines.
a.
A 5-year projected income statement
b.
A 5-year projected cash flow
c.
Net present value (NPV)
d.
Internal rate of return (IRR)
e.
Based on items (a) through (d), which company would you
recommend acquiring?
f.
Write a paper of no more 1,050 words that defines, analyzes,
and interprets the answers to items (c) and (d). Present the
rationale behind each item and why it supports your decision
stated in item (e). Also, attempt to describe the relationship
between NPV and IRR. (
Hint.
3. The key factor is the discount rate used.)
In addition to the paper, a Micosoft
®
Excel
®
spreadsheet showing your projections and calculations must be
shown and attached.
Capital Budgeting – Clarification Example
When people hear the term
capital budgeting
, they usually focus on the budgeting part of the term rather
than the capital portion. Actually, capital is the more important
aspect because it shows you that you are evaluating a larger
expenditure that will be capitalized—in other words,
depreciated over time.
Remember, a capital expenditure can be many things—a large
copying machine, an automated assembly line, a building, or the
ultimate in capital budgeting—the acquisition of another entity.
What is important about capital budgeting is it allows you to
analyze one or more projects so you can intelligently and
strategically decide on which project you wish to acquire or
which piece of equipment you should procure.
There are at least six capital budgeting tools you can use in
analyzing a capital expenditure: net present value (NPV),
internal rate of return (IRR), profitability index (PI), payback
period (PB), discounted payback period (DPB), and modified
internal rate of return (MIRR), although the textbook mainly
focuses on net NPV and IRR. In a prior finance course,
you might have learned how to calculate four of the six tools—
4. NPV, IRR, PI, and PB. If not, then this will be new material for
you.
Crunching the numbers might seem by some to be the more
crucial part—and it is indeed important.
However, interpreting and analyzing the answers are just as
important. See if you can do this with the six capital budgeting
tool answers that you will be computing in the following
example.
Example
Suppose you are thinking of acquiring either the ABC or the
XYZ Company. Both have a purchase price of $500K so you
cannot readily see which choice would be in your best interest.
You also have a capital restraint of approximately $500K so you
cannot purchase both entities. Thus, you provide your
accountants and analysts with the historical financial details of
both companies. They spend a few days forecasting 5 years of
detailed financial statements based on how your company would
operate these two corporations. The following are the results
that ended with the projected 5-year net cash flow figures. Year
0 shows the initial cost outlay (or purchase price), and years 1
through 5 show the projected cash inflow if you make the
purchase.
0
1
2
3
4
5
5. ABC
-500
100
200
575
325
100
XYZ
-500
275
250
75
250
450
It is an interesting coincidence to note that if you total both
rows for each company, they are the same.
However, you know that this does not matter in that comparing
totals ignores the time value of money and is not a valid capital
budgeting tool in making strategic decisions for your firm.
Let’s first look at two of the more popular capital budgeting
tools, NPV and IRR. As you are doing, you always look at the
6. projected cash flows for each project—not net income. To
compare the projects on equal terms, you bring back the future
cash flows to the present, which is the present value concept.
Then, you subtract the cost of that project from its present
value—thus, NPV.
Before you start this process, you need a discount rate—the
interest rate used in the NPV formula. Sometimes it is called the
hurdle rate or required rate of return. It is usually the cost of
capital—sometimes with a risk factor added, if it is a risky
project. The cost of capital is used because you want this
project to at least make more than what capital is now costing
you to run your business—otherwise, the project will lose the
firm cash. In this example, you are using a discount rate of
10%. Thus, if your NPV is positive—it is a good project. If it is
negative, it is considered a poor project. In comparing projects,
you want to pick the one with the highest NPV.
Net Present Value
ABC
$472.28
XYZ
$463.13
As you can see (you may check these figures with your
spreadsheet program or financial calculator), ABC has a slightly
higher NPV. Therefore, ABC would be your choice based on
7. this one capital budgeting tool. You should note that NPV is
considered the most superior capital budgeting tool.
Now, how would you interpret or define your NPV answer? A
textbook might define NPV as the present value of future cash
returns, discounted at the appropriate interest rate, less the cost
of the investment.
If you explain it that way to most people, they might give you a
blank stare. Yes, you should pick ABC because its NPV is
higher than XYZ.
However, here is the key interpretation that all will
understand—ABC will be giving you, over 5 years, a current
value cash return of approximately $472.3K above your 10%
required rate of return. In other words, this project will not only
meet your 10% required return, but it will give you an
additional $472.3K.
The next question is, what total percentage return does the
dollar amount represent? This is exactly what IRR tells you.
The IRR calculations are as follows:
Internal Rate of Return
ABC
38.58%
XYZ
40.01%
Therefore, your total current valued percentage return on your
investment for ABC = 38.58%. IRR is a percentage that will go
with NPV most of the time.
NPV told you to choose ABC Company. Your IRR computations
8. are giving you conflicting directions telling you to choose XYZ
Company. Consider that IRR can have two problem areas—more
than one negative in the cash flow, or if there are large
fluctuations in cash flows from year to year. Either of these two
problems can result in non-accurate IRR answers. If you
noticed, there were some large fluctuations in your cash flow. If
you get an IRR decision that conflicts with NPV, you always
choose the higher NPV.
Here is an exercise to give you an idea of how NPV is related to
IRR. Suppose you are using a discount rate of 10%. If you have
an NPV of exactly $0, your IRR will be 10%. If your NPV is
above $0, your IRR will be above 10%. If your NPV is below
$0, your IRR will be below 10%. You can prove this by taking
ABC’s IRR of 35.58% and using it as the discount rate in the
NPV formula. Recalculate NPV using the 35.58% discount rate
and you will get an NPV that is very close to $0.
You know that IRR can have its problems—this is why they
came up with MIRR. MIRR solves the problems that may occur
in IRR computations. MIRR can be calculated automatically
with some financial calculators and it is also an
fx
function in Microsoft
®
Excel
®
. Here are the results of your example:
Modified Internal Rate of Return
ABC
25.65%
9. XYZ
25.41%
As you can see, MIRR’s capital budgeting decision matches that
of the calculated NPV. Company ABC is slightly higher than
company XYZ. You can also calculate MIRR using just the
basic time value of money functions of a financial calculator.
There is an example of this at the end of this document.
PI is another tool. It goes together with NPV and never conflicts
with NPV’s findings. The easiest way to calculate PI is as
follows:
PI = PV/ICO, that is, present value divided by the initial cost
outlay. Most textbooks use this formula; however, some
textbooks use the formula PI = NPV/ICO, PI = net present value
divided by the initial cost outlay.
The simplest way to get PV is after you have calculated NPV.
PV = NPV + ICO. In your example using ABC company, it
would be PV = 472.28 + 500 = 972.28. Now you can calculate
PI = 972.28 / 500 = 1.94.
Profitabilty Index
ABC
1.94
XYZ
1.93
10. Remember, PI is just an index number—anything 1.0 and higher
is affirmation for the project you are evaluating. So the next
question: If PI goes hand in hand with NPV, then why do you
even need to calculate PI?
PI is a type of ratio that gives the highest NPV per dollar of
investment. PI comes more into play when you are comparing
many projects. One textbook describes it as:
The PI is sometimes used to rank projects even when there is no
soft or hard capital rationing. In this case the unwary user may
be led to favor small projects over larger projects with higher
NPV’s. The PI was designed to select the projects with the most
bang per buck—the greatest NPV per dollar spent. That is the
right objective when bucks are limited. When they are not, a
bigger bang is always better than a smaller one, even when more
bucks are spent (Brealey, 1988, p. 201).
PB method is the most inferior of all basic capital budgeting
tools because it does not consider the time value of money—for
example, if a project will cost $500 to start and is projecting
$100 per year cash inflow for the first 10 years, then the
payback period is 5.0 years—the amount of time it takes the
cash inflow to pay for the original cash outflow or cost of the
project. Of course, this ignores the time value of money treating
a dollar in any future year the same in value as a dollar today.
The decision-making criteria for the payback method is going
with the project that pays off the initial cost outlay in less time.
As you can see by the following calculations, you have another
conflict. Your NPV indicated that company ABC is the correct
choice; however, PB states that company XYZ is the choice.
You can see that not only does the PB method ignore the time
value of money, but it also does not consider all years of the
cash flow projection. For example, XYZ showed that its
payback was in less than 2 years ignoring the last 3 years as
being a factor.
11. Note.
There will be an example of an easy way to calculate PB at the
end of this document.
Payback Period
ABC
2.35
yrs
XYZ
1.90
yrs
The last tool to introduce is discounted payback period (DPB).
While this method also ignores some of the future cash flow
projections much like the PB method, it does consider the time
value of money. The DPB is computed in a similar fashion as
the PB method—the only difference is that the DPB method
uses the discounted cash flow. As you can see in the following,
factoring in the time value of money makes the decision in line
with the NPV’s outcome—ABC is the choice!
Discount Payback Period
ABC
2.56
yrs
XYZ
2.77
12. yrs
The following is a quick glance summary of the capital
budgeting tool answers—note that the preferred choice based on
each capital budgeting tool’s criteria is highlighted:
ABC
XYZ
NPV
$472.28
$463.13
IRR
38.58%
40.01%
MIRR
2
5.65%
25.41%
PI
1.94
1.93
PB
2.35
yrs
1.9
DPB
2.56
yrs
2.77
13. Remember that if there is any question as to the validity of the
calculations, NPV should always be used as the final decision
factor.
Example
MIRR Calculation Example and Hints
Discount rate = 10%
Projected
Cash flow years 0 1 2 3 4 5
Project A (500) 45 55 65 175 185
First, you must take all of years (except year 0) out to year 5
using the future value function of your financial calculator.
MIRR takes everything out to the future first before discounting
it back tothe present. Take year 1 for example—to get this
year’s value out to year 5, you must use the future value (FV)
function:
PV = 45
i = 10
n = 4 because it is 4 years to get to year 5
Solving for FV = 65.68
FV - YR5 = 185.00
14. FV - YR4 = 192.50
FV - YR3 = 78.65
FV - YR2 = 73.21
FV - YR1 = 65.88
Terminal value (total of years 1 through 5) = 595.24
Once this process has been done for each year, you add them to
get what is called the terminal value. Now, you have all of the
numbers to calculate MIRR:
FV = 595.24
PV = (500.00)
n = 5
Solving for i = 3.55%
MIRR is 3.55%, which will almost always be more
conservative than IRR. Of course, because MIRR is below your
required rate of return, it is a thumbs-down on this project.
Make sure that you calculate the above answer to see if you can
come up with the same solution.
Remember, always make sure your PV is entered as a negative,
or you will get an error when solving for
i
.
15. Payback Calculation Example and Hints
Suppose you had 5 years of cash flow as follows (year 0 being
the initial cost outlay):
YR0 = -500 YR1 = 120 YR2 = 100 YR3 = 110 YR4 = 100
YR5 = 280
You would always start with the initial cost outlay and then
subtract every year until you are at the last year that would put
your total below zero:
500 - 120 - 100 - 110 - 100 = 70
The reason to not subtract year 5 is because that would put you
below 0.
Now you know that the payback is 4 full years plus a
fraction. How do you find the fractional part of the 5th
year? You take the leftover 70 and divide by the 280 in year 5—
this gives you a fraction of .25.
Therefore, the payback = 4.25 years.
Note that discounted payback is calculated in the same manner,
but the discounted cash flow would be used.
Reference
Brealey, R. A.,Myers, S. C., & Marcus,
(2007).
Fundamentals of corporate finance
(5
th
edition).New York, NY:McGraw-Hill International.