The document discusses various techniques for risk analysis in capital budgeting including probability, variance, coefficient of variation, payback period, risk-adjusted discount rate, certainty equivalent, sensitivity analysis, scenario analysis, simulation analysis, decision trees, and utility theory. It provides details on how to apply each technique and highlights their benefits and limitations.
Discusses various risks involved in capital budgeting - useful to the students of under graduate, post graduate and professional course students in finance and management
Investment analysis and portfolio management quantitative methods of investme...Arif Hossain FCA
The objective of investment analysis and portfolio management study is to help entrepreneurs and practitioners to understand the investments field as it is currently understood and practiced for sound investment decisions making. Following this objective, key concepts are presented to provide an appreciation of the theory and practice of investments, focusing on investment portfolio formation and management issues. This study is designed to emphasize both theoretical and analytical aspects of investment decisions and deals with modern investment theoretical concepts and instruments. Both descriptive and quantitative materials on.............................
Discusses various risks involved in capital budgeting - useful to the students of under graduate, post graduate and professional course students in finance and management
Investment analysis and portfolio management quantitative methods of investme...Arif Hossain FCA
The objective of investment analysis and portfolio management study is to help entrepreneurs and practitioners to understand the investments field as it is currently understood and practiced for sound investment decisions making. Following this objective, key concepts are presented to provide an appreciation of the theory and practice of investments, focusing on investment portfolio formation and management issues. This study is designed to emphasize both theoretical and analytical aspects of investment decisions and deals with modern investment theoretical concepts and instruments. Both descriptive and quantitative materials on.............................
Real Options, Investment Analysis and Process PANKAJ PANDEY
Understand the capital budgeting process:
Document the policies and practices of companies in India and compare them with that of the companies in developed countries.
Understand the linkage between corporate strategy and investment decisions.
Define strategic real options.
Show the valuation of real options.
The perils of rule of thumb in valuationsaurabh1722
Valuation is considered very subjective and hence many companies or consultants use rule of thumb leading to incorrect valuation. This report discusses a real case study of a company who used rule of thumb to conduct a product valuation. The names as well as the numbers used are withheld for confidentiality purposes.
Risk-Adjusted Discount Rate (RADR) is sum total of two components. And these components are the risk-free rate and the risk premium.
To know more about it, click on the link given below:
https://efinancemanagement.com/investment-decisions/risk-adjusted-discount-rate
AgendaComprehending risk when modeling investment (project) de.docxgalerussel59292
Agenda
Comprehending risk when modeling investment (project) decisions
Standalone Risk
Market Risk
1
1
Project Risk
Standalone Risk: Risk based on uncertainty of a projects cash flows
Sensitivity
Scenarios
Breakeven
Simulations
Market Risk: Risk of the project as seen by a well diversified investor
Beta
2
Sensitivity, Scenario, and Break-Even
Each allows us to look behind the NPV number to see how stable our estimates are.
Breakeven: sales required to breakeven
Accounting break-even: sales volume at which net income = 0
Cash break-even: sales volume at which operating cash flow = 0
Financial break-even: sales volume at which net present value = 0
Sensitivity: how sensitive a particular NPV calculation is to changes in an input variable holding all other assumptions are held constant
Scenario: examine impact on NPV given a confluence of factors
When working with spreadsheets, try to build your model so that you can adjust variables in a single cell and have the NPV calculations update accordingly.
3
3
Monte Carlo Simulation
A more sophisticated variation of the scenario analysis is Monte Carlo simulation.
In a Monte Carlo simulation, analysts specify a range or a distribution of potential outcomes for each of the model’s assumptions.
Pick a probability distribution for each input variable (units, price, variable costs, etc).
The computer program will pick a random value from each input variable, calculate the NPV and store the result. This is a trial.
Repeat the process many times, saving the input variables and the output (NPV).
End result: Probability distribution of NPV based on sample of simulated values.
4
Example
5
6
When a firm with both debt and equity invests in an asset similar to its existing assets (business), the WACC is the appropriate discount rate to use in NPV calculations.
In conglomerates, the WACC reflects the return that the firm must earn on average across all its assets to satisfy investors, but using the WACC to discount cash flows of a particular investment leads to mistakes.
Any project’s cost of capital depends on the use to which the capital is being put—not the source.
Therefore, it depends on the risk of the project and not the risk of the company.
When a firm invests in an asset that is different from its existing assets, it should look for pure-play firms to find the right discount rate.
6
Finding the Right Discount Rate
6
You are a financial analyst at General Electric and are preparing a cost of equity estimate for a project analysis using NPV:
CAPM = Risk Free Rate + Beta * Market Risk Premium
9.5% = 3.0% + 1.1 * 5.9%
Lines of Business
Financial Services
Power Generation
Aviation
Transportation
Health Care
Consumer Goods
When evaluating a new power generation investment for GE, which cost of capital should be used?
Capital Budgeting & Project Risk
7
Beta
1.8
0.6
1.2
1.3
0.8
1.1
7
17
Capital Budgeti.
Discuss the concept of risk in investment decisions.
Understand some commonly used techniques, i.e., payback, certainty equivalent and risk-adjusted discount rate, of risk analysis in capital budgeting.
Focus on the need and mechanics of sensitivity analysis and scenario analysis.
Highlight the utility and methodology simulation analysis.
Explain the decision tree approach in sequential investment decisions.
Focus on the relationship between utility theory and capital budgeting decisions.
Real Options, Investment Analysis and Process PANKAJ PANDEY
Understand the capital budgeting process:
Document the policies and practices of companies in India and compare them with that of the companies in developed countries.
Understand the linkage between corporate strategy and investment decisions.
Define strategic real options.
Show the valuation of real options.
The perils of rule of thumb in valuationsaurabh1722
Valuation is considered very subjective and hence many companies or consultants use rule of thumb leading to incorrect valuation. This report discusses a real case study of a company who used rule of thumb to conduct a product valuation. The names as well as the numbers used are withheld for confidentiality purposes.
Risk-Adjusted Discount Rate (RADR) is sum total of two components. And these components are the risk-free rate and the risk premium.
To know more about it, click on the link given below:
https://efinancemanagement.com/investment-decisions/risk-adjusted-discount-rate
AgendaComprehending risk when modeling investment (project) de.docxgalerussel59292
Agenda
Comprehending risk when modeling investment (project) decisions
Standalone Risk
Market Risk
1
1
Project Risk
Standalone Risk: Risk based on uncertainty of a projects cash flows
Sensitivity
Scenarios
Breakeven
Simulations
Market Risk: Risk of the project as seen by a well diversified investor
Beta
2
Sensitivity, Scenario, and Break-Even
Each allows us to look behind the NPV number to see how stable our estimates are.
Breakeven: sales required to breakeven
Accounting break-even: sales volume at which net income = 0
Cash break-even: sales volume at which operating cash flow = 0
Financial break-even: sales volume at which net present value = 0
Sensitivity: how sensitive a particular NPV calculation is to changes in an input variable holding all other assumptions are held constant
Scenario: examine impact on NPV given a confluence of factors
When working with spreadsheets, try to build your model so that you can adjust variables in a single cell and have the NPV calculations update accordingly.
3
3
Monte Carlo Simulation
A more sophisticated variation of the scenario analysis is Monte Carlo simulation.
In a Monte Carlo simulation, analysts specify a range or a distribution of potential outcomes for each of the model’s assumptions.
Pick a probability distribution for each input variable (units, price, variable costs, etc).
The computer program will pick a random value from each input variable, calculate the NPV and store the result. This is a trial.
Repeat the process many times, saving the input variables and the output (NPV).
End result: Probability distribution of NPV based on sample of simulated values.
4
Example
5
6
When a firm with both debt and equity invests in an asset similar to its existing assets (business), the WACC is the appropriate discount rate to use in NPV calculations.
In conglomerates, the WACC reflects the return that the firm must earn on average across all its assets to satisfy investors, but using the WACC to discount cash flows of a particular investment leads to mistakes.
Any project’s cost of capital depends on the use to which the capital is being put—not the source.
Therefore, it depends on the risk of the project and not the risk of the company.
When a firm invests in an asset that is different from its existing assets, it should look for pure-play firms to find the right discount rate.
6
Finding the Right Discount Rate
6
You are a financial analyst at General Electric and are preparing a cost of equity estimate for a project analysis using NPV:
CAPM = Risk Free Rate + Beta * Market Risk Premium
9.5% = 3.0% + 1.1 * 5.9%
Lines of Business
Financial Services
Power Generation
Aviation
Transportation
Health Care
Consumer Goods
When evaluating a new power generation investment for GE, which cost of capital should be used?
Capital Budgeting & Project Risk
7
Beta
1.8
0.6
1.2
1.3
0.8
1.1
7
17
Capital Budgeti.
Discuss the concept of risk in investment decisions.
Understand some commonly used techniques, i.e., payback, certainty equivalent and risk-adjusted discount rate, of risk analysis in capital budgeting.
Focus on the need and mechanics of sensitivity analysis and scenario analysis.
Highlight the utility and methodology simulation analysis.
Explain the decision tree approach in sequential investment decisions.
Focus on the relationship between utility theory and capital budgeting decisions.
Chapter- III Techniques of Capital Budgeting
Concept, Significance, Nature and classification of capital budgeting decisions, cash flow computation- Incremental approach; Evaluation criteria- Pay Back Period, ARR, NPV, IRR and PI methods; capital rationing, Capital budgeting under risk and uncertainty.
1RUNNING HEAD Genesis Energy Capital Plan Report2Genesi.docxeugeniadean34240
1
RUNNING HEAD: Genesis Energy Capital Plan Report
2
Genesis Energy Capital Plan Report
Genesis Energy Capital Plan Report
Module 5 Assignment 2
Argosy University Online
Katrina Caver
The decision on capital outlays is among the most significant a firm has to make. A decision to build a new plant or expand into a foreign market may influence the performance of the firm over the next ten years. The capital budgeting decision includes the planning of expenditures for a project with a life of at least one year and usually considerably longer. Capital budgeting assists with the decision making of how a firm should invest its capital.
Different capital budgeting alternatives that are used includes the payback period, which calculates the amount of time it will take before the cumulative net cash flows are equal to the initial cost of the investment (Argosy Online University, 2012); accounting rate of return (return on investment, An indicator of profitability that is measured by dividing the accounting net income by the amount invested (AccountingCoach, 2004-2015)); discounted payback period(examines the time that is required to cover the investment of the project considering the present value of all the cash inflows); net present value(measures the present value of all the cash inflow from the project and compare the same with the initial investment); profitability index(measures the present value of cash inflows at the required rate of cash inflows at the rate of return that is required to for the initial cash outflow for the investment. However, if the present value of cash inflows is positive, then the project is accepted; if the project is negative, then the project is not accepted.
Upon evaluating the capital budget, the outcomes include cost of debt at eight percent, cost of equity at ten percent, short-term interest rate at eight percent, long-term interest rate at nine percent, and long-term equity interest rate at ten percent. Operating projections for a project is utilized to establish a forecast for cash flows that would underpin calculations of net present value, internal rates of return, payback period, and other investment metrics. The purpose of forecasting cash flows is to capture the incremental effect of a proposed project. Each project’s cash flow forecasts does not include depreciation expenses and cost that would be incurred regardless of whether a given project was undertaken or not. High, medium, and low risks categories for each division were associated with a corresponding discount rate set by the capital budgeting committee in consultation with the corporate treasurer.
The weighted average cost of capital is another method to evaluate proposed projects and capital budgeting. By computing a weighted average, the company can decide the interest for every dollar that is invested. Cost of capital assist with the determination of the minimum rate of return a company is expected to make from the project. Wei.
Part 1Halliburton company beta 1.6, Helix energy solutions beta .docxsmile790243
Part 1
Halliburton company beta 1.6, Helix energy solutions beta 1.71, Superior energy services beta 1.69 and Schlumberger limited 1.65
Beta is the extent of a company’s stock's tremor, similar to the general market. By definition, the market, for instance, has a beta of 1.0, and individual stocks are situated by the sum they veer off.
Stocks that change all the more frequently after some time have a beta above 1.0. If a stock moves not decisively the market, the stock's beta is under 1.0. High-beta stocks ought to be progressively risky; notwithstanding, give better yield potential; low-beta stocks present less danger yet also lower returns.
One course for a stock money related authority to consider an opportunity is to part it into two characterizations. The fundamental class is called efficient peril, which is the threat of the entire market declining. The money related crisis in 2008 is an instance of a productive peril event when no proportion of expanding could shield examiners from losing a motivating force in their stock portfolios. Systematic hazard is, in any case, called un-diversifiable risk.
Unsystematic or diversifiable perils are identified with an individual stock. The surprising assertion that Lumber Liquidators (LL) had been selling hardwood flooring with unsafe degrees of formaldehyde in 2015 is an instance of an unsystematic peril that was express to that association. Unsystematic hazards can be, for the most part, directed through expanding.
A beta of 1.0 shows that its worth activity is immovably connected to the industry. A stock that has a beta of 1.0 indicates a valid risk. In any case, the beta estimation can't perceive any unsystematic hazard.
A beta estimation of under 1.0 suggests that the security is theoretically less eccentric than the market, which implies the portfolio is less risky with the stock included than without it. For example, utility stocks consistently have low betas since they will, by and large, move more continuously than grandstand midpoints.
Another factor that is incorporated would be the capital structure of each firm. Firms that have assorted capital structures will have different betas. For example, an association with less commitment financing will have a lower beta than an association with higher commitment financing.
Section 2: Capital Budgeting
IRR and NPV are both used in the evaluation methodology for capital utilization. Net present worth (NPV) limits the flood of expected wages identified with a proposed dare to their present value, which presents a cash surplus or deficiency for the undertaking. Internal rate of return (IRR) figures the evaluated speed of return at which those proportional earnings will achieve a net present estimation of zero. The two capital arranging systems have some similarities and differences listed: Result. The NPV system realizes dollar regard that an errand will convey, while IRR produces the rate return that the endeavor is required to make.
Reason. The.
RUNNING HEAD CAPITAL BUDGETING ASSIGNMENT7CAPITAL BUDGETI.docxsusanschei
RUNNING HEAD: CAPITAL BUDGETING ASSIGNMENT
7
CAPITAL BUDGETING ASSIGNMENT
Capital Budgeting Assignment –
The Coca Cola Company
I. Introduction
Companies are regularly faced with decisions concerning investments in long-lived assets to promote continuous growth and expansion of business operations. Long-lived assets are expected to return benefits for more than a year (Peterson & Fabozzi, 2002). Capital budgeting is the process of analyzing different investment options and the selection of which identified investment opportunities to pursue (Peterson & Fabozzi, 2002). Having established guidelines and criteria for the selection of projects is crucial for capital budgeting.
The capital budgeting techniques analyzed and used in this paper will be the Net Present Value (NPV), the Internal Rate of Return (IRR), Modified Rate of Return (MIRR) and Profitability Index (PI). The Proposed Capital Budgeting Project – Expansion of Partnership with Keurig Green Mountain, Inc. – will be described and analyzed in an Excel Capital Budgeting Model. The results of the Excel model will be explained and interpreted based on the capital budgeting criteria introduced and a recommendation about the implementation of the proposed capital budgeting project will be discussed.
II. Description of Proposed Capital Budgeting Project
Coca Cola acquired 16% of the Keurig Green Mountain, Inc. (GMCR) in 2014, making it the largest shareholder of the coffee brewer company (Trefis Team, 2014). The Coca Cola Company (KO) purchased these 6.5 million shares for an agreed purchase price of $830 million (Coca Cola, 2015). The announcement of the acquisition raised Coca Cola’s stock by 0.7% (Trefis Team, 2014). The two companies are developing a new brewer system together, the Keurig Cold to be able to tap in the growing demand of ready-to-drink at-home-brewed beverages and expand into the cold drink market (Trefis Team, 2014).
GMCR’s market size has expanded to $19bn and is expected to continue to grow (Trefis Team, 2014). Considering the 16% ownership Coca Cola has of GMCR this is a $3.04bn return for KO on their investment. Considering these impressive numbers an expansion in the partnership between KO and GMCR to a total of 20% of ownership in GMCR should be considered. Based on the purchase price of $830 million for 16% equity, the expansion by another 4% would lead to an initial cash outflow of $207.5 million. Considering the return on the investment of $3bn for 16% equity in GMCR the cash inflows over the next six years after an additional 4% investment is to be estimated at $750 million in Year 1, $700 million in Year 2, $600 million in Year 3, $500 in Year 4, $400 million in Year 5, $300 million in Year 6 and $200 million in Year 7. This estimate is very conservative and considers possible future trends in the beverage market and competitors adapting the new cold brewing mechanism. After a cash inflow of $750 million in the first year, the cash inflows ...
The European Unemployment Puzzle: implications from population agingGRAPE
We study the link between the evolving age structure of the working population and unemployment. We build a large new Keynesian OLG model with a realistic age structure, labor market frictions, sticky prices, and aggregate shocks. Once calibrated to the European economy, we quantify the extent to which demographic changes over the last three decades have contributed to the decline of the unemployment rate. Our findings yield important implications for the future evolution of unemployment given the anticipated further aging of the working population in Europe. We also quantify the implications for optimal monetary policy: lowering inflation volatility becomes less costly in terms of GDP and unemployment volatility, which hints that optimal monetary policy may be more hawkish in an aging society. Finally, our results also propose a partial reversal of the European-US unemployment puzzle due to the fact that the share of young workers is expected to remain robust in the US.
The secret way to sell pi coins effortlessly.DOT TECH
Well as we all know pi isn't launched yet. But you can still sell your pi coins effortlessly because some whales in China are interested in holding massive pi coins. And they are willing to pay good money for it. If you are interested in selling I will leave a contact for you. Just telegram this number below. I sold about 3000 pi coins to him and he paid me immediately.
Telegram: @Pi_vendor_247
Empowering the Unbanked: The Vital Role of NBFCs in Promoting Financial Inclu...Vighnesh Shashtri
In India, financial inclusion remains a critical challenge, with a significant portion of the population still unbanked. Non-Banking Financial Companies (NBFCs) have emerged as key players in bridging this gap by providing financial services to those often overlooked by traditional banking institutions. This article delves into how NBFCs are fostering financial inclusion and empowering the unbanked.
how to sell pi coins effectively (from 50 - 100k pi)DOT TECH
Anywhere in the world, including Africa, America, and Europe, you can sell Pi Network Coins online and receive cash through online payment options.
Pi has not yet been launched on any exchange because we are currently using the confined Mainnet. The planned launch date for Pi is June 28, 2026.
Reselling to investors who want to hold until the mainnet launch in 2026 is currently the sole way to sell.
Consequently, right now. All you need to do is select the right pi network provider.
Who is a pi merchant?
An individual who buys coins from miners on the pi network and resells them to investors hoping to hang onto them until the mainnet is launched is known as a pi merchant.
debuts.
I'll provide you the Telegram username
@Pi_vendor_247
what is the future of Pi Network currency.DOT TECH
The future of the Pi cryptocurrency is uncertain, and its success will depend on several factors. Pi is a relatively new cryptocurrency that aims to be user-friendly and accessible to a wide audience. Here are a few key considerations for its future:
Message: @Pi_vendor_247 on telegram if u want to sell PI COINS.
1. Mainnet Launch: As of my last knowledge update in January 2022, Pi was still in the testnet phase. Its success will depend on a successful transition to a mainnet, where actual transactions can take place.
2. User Adoption: Pi's success will be closely tied to user adoption. The more users who join the network and actively participate, the stronger the ecosystem can become.
3. Utility and Use Cases: For a cryptocurrency to thrive, it must offer utility and practical use cases. The Pi team has talked about various applications, including peer-to-peer transactions, smart contracts, and more. The development and implementation of these features will be essential.
4. Regulatory Environment: The regulatory environment for cryptocurrencies is evolving globally. How Pi navigates and complies with regulations in various jurisdictions will significantly impact its future.
5. Technology Development: The Pi network must continue to develop and improve its technology, security, and scalability to compete with established cryptocurrencies.
6. Community Engagement: The Pi community plays a critical role in its future. Engaged users can help build trust and grow the network.
7. Monetization and Sustainability: The Pi team's monetization strategy, such as fees, partnerships, or other revenue sources, will affect its long-term sustainability.
It's essential to approach Pi or any new cryptocurrency with caution and conduct due diligence. Cryptocurrency investments involve risks, and potential rewards can be uncertain. The success and future of Pi will depend on the collective efforts of its team, community, and the broader cryptocurrency market dynamics. It's advisable to stay updated on Pi's development and follow any updates from the official Pi Network website or announcements from the team.
What website can I sell pi coins securely.DOT TECH
Currently there are no website or exchange that allow buying or selling of pi coins..
But you can still easily sell pi coins, by reselling it to exchanges/crypto whales interested in holding thousands of pi coins before the mainnet launch.
Who is a pi merchant?
A pi merchant is someone who buys pi coins from miners and resell to these crypto whales and holders of pi..
This is because pi network is not doing any pre-sale. The only way exchanges can get pi is by buying from miners and pi merchants stands in between the miners and the exchanges.
How can I sell my pi coins?
Selling pi coins is really easy, but first you need to migrate to mainnet wallet before you can do that. I will leave the telegram contact of my personal pi merchant to trade with.
Tele-gram.
@Pi_vendor_247
when will pi network coin be available on crypto exchange.DOT TECH
There is no set date for when Pi coins will enter the market.
However, the developers are working hard to get them released as soon as possible.
Once they are available, users will be able to exchange other cryptocurrencies for Pi coins on designated exchanges.
But for now the only way to sell your pi coins is through verified pi vendor.
Here is the telegram contact of my personal pi vendor
@Pi_vendor_247
how can i use my minded pi coins I need some funds.DOT TECH
If you are interested in selling your pi coins, i have a verified pi merchant, who buys pi coins and resell them to exchanges looking forward to hold till mainnet launch.
Because the core team has announced that pi network will not be doing any pre-sale. The only way exchanges like huobi, bitmart and hotbit can get pi is by buying from miners.
Now a merchant stands in between these exchanges and the miners. As a link to make transactions smooth. Because right now in the enclosed mainnet you can't sell pi coins your self. You need the help of a merchant,
i will leave the telegram contact of my personal pi merchant below. 👇 I and my friends has traded more than 3000pi coins with him successfully.
@Pi_vendor_247
Falcon stands out as a top-tier P2P Invoice Discounting platform in India, bridging esteemed blue-chip companies and eager investors. Our goal is to transform the investment landscape in India by establishing a comprehensive destination for borrowers and investors with diverse profiles and needs, all while minimizing risk. What sets Falcon apart is the elimination of intermediaries such as commercial banks and depository institutions, allowing investors to enjoy higher yields.
US Economic Outlook - Being Decided - M Capital Group August 2021.pdfpchutichetpong
The U.S. economy is continuing its impressive recovery from the COVID-19 pandemic and not slowing down despite re-occurring bumps. The U.S. savings rate reached its highest ever recorded level at 34% in April 2020 and Americans seem ready to spend. The sectors that had been hurt the most by the pandemic specifically reduced consumer spending, like retail, leisure, hospitality, and travel, are now experiencing massive growth in revenue and job openings.
Could this growth lead to a “Roaring Twenties”? As quickly as the U.S. economy contracted, experiencing a 9.1% drop in economic output relative to the business cycle in Q2 2020, the largest in recorded history, it has rebounded beyond expectations. This surprising growth seems to be fueled by the U.S. government’s aggressive fiscal and monetary policies, and an increase in consumer spending as mobility restrictions are lifted. Unemployment rates between June 2020 and June 2021 decreased by 5.2%, while the demand for labor is increasing, coupled with increasing wages to incentivize Americans to rejoin the labor force. Schools and businesses are expected to fully reopen soon. In parallel, vaccination rates across the country and the world continue to rise, with full vaccination rates of 50% and 14.8% respectively.
However, it is not completely smooth sailing from here. According to M Capital Group, the main risks that threaten the continued growth of the U.S. economy are inflation, unsettled trade relations, and another wave of Covid-19 mutations that could shut down the world again. Have we learned from the past year of COVID-19 and adapted our economy accordingly?
“In order for the U.S. economy to continue growing, whether there is another wave or not, the U.S. needs to focus on diversifying supply chains, supporting business investment, and maintaining consumer spending,” says Grace Feeley, a research analyst at M Capital Group.
While the economic indicators are positive, the risks are coming closer to manifesting and threatening such growth. The new variants spreading throughout the world, Delta, Lambda, and Gamma, are vaccine-resistant and muddy the predictions made about the economy and health of the country. These variants bring back the feeling of uncertainty that has wreaked havoc not only on the stock market but the mindset of people around the world. MCG provides unique insight on how to mitigate these risks to possibly ensure a bright economic future.
1. Techniques for Risk Analysis Statistical Techniques for Risk Analysis Probability Variance or Standard Deviation Coefficient of Variation Conventional Techniques of Risk Analysis Payback Risk-adjusted discount rate Certainty equivalent
2. Project Return & CAPM Derive Levered Beta from Equity Beta Average the samples for asset the beta Cost of equity is The project cost of capital is the weighted average.
3. Year 0 1 2 Cash flows (Rs. in lakhs) – 1600 10000 –10000 PP Ltd. is considering an expansion project to strengthen its existing businesses. For this project, it proposes to employ debt-equity ratio of 2.5. Its pre-tax cost of debt will be 12% and its expected tax rate is 35%. The incremental cash flows from the project are given below:
4. Company Equity-beta D/E ratio Jai Ltd. 1.40 2.25 Ayu Ltd. 1.25 1.80 Taru Ltd. 1.30 2.00 The equity-betas and debt-equity ratios of three companies engaged in the similar business are given below: The risk-free rate is 6% and the expected return on market portfolio is 18%. Estimate the required rate of return on the expansion project. Also, appraise the project based on IRR.
5.
6. Abandonment Analysis Super Projects Ltd. has undertaken a project a few years ago. The project is still running and has a remaining useful life of 6 years. The company now feels that the project does not fit into its overall strategy and is considering whether it should be abandoned. The following information is available: Year Cash flow (Rs.Crore) Value if sold (Rs.Crore) 1 175 510 2 200 475 3 235 400 4 350 300 5 400 200 6 100 50 The cost of capital of the company is 22%. Decide whether the project should be abandoned, and if yes, in which year.
7.
8. Year 0 1 2 3 4 5 6 7 Abandonment Value 200 120 90 60 40 20 10 – Chi Ltd. has bought one sugar mill near Hapur at a cost of Rs.200 crore. The investment horizon of the company is seven years. The management of the company gathered information regarding abandonment price of this mill in next seven years, as follows: The opportunity cost of capital to the company is 12%. Cash inflow of the company increases by 25% every year in first four years, and then gradually it decreases by 50% every year. With this information the investment expert says that abandoning this project at the end of 4th year is a no-gain-no-loss proposition to the company. Conduct abandonment analysis and comment.
9. Mean & SD of Cash Flows Correlated cash flows Unrelated cash flows
10.
11.
12. Coefficient of Variation Relative Measure of Risk It is defined as the standard deviation of the probability distribution divided by its expected value:
13. Coefficient of Variation The coefficient of variation is a useful measure of risk when we are comparing the projects which have (i) same standard deviations but different expected values, or (ii) different standard deviations but same expected values, or (iii) different standard deviations and different expected values.
14. Risk-Adjusted Discount Rate Risk-adjusted discount rate, will allow for both time preference and risk preference and will be a sum of the risk-free rate and the risk-premium rate reflecting the investor’s attitude towards risk. Under CAPM, the risk-premium is the difference between the market rate of return and the risk-free rate multiplied by the beta of the project.
15. Evaluation of Risk-adjusted Discount Rate The following are the advantages of risk-adjusted discount rate method: It is simple and can be easily understood. It has a great deal of intuitive appeal for risk-averse businessman. It incorporates an attitude (risk-aversion) towards uncertainty. This approach, however, suffers from the following limitations: There is no easy way of deriving a risk-adjusted discount rate. As discussed earlier, CAPM provides for a basis of calculating the risk-adjusted discount rate. Its use has yet to pick up in practice. It does not make any risk adjustment in the numerator for the cash flows that are forecast over the future years. It is based on the assumption that investors are risk-averse. Though it is generally true, there exists a category of risk seekers who do not demand premium for assuming risks; they are willing to pay a premium to take risks.
18. Risks of Certainty—Equivalent First, the forecaster, expecting the reduction that will be made in his forecasts, may inflate them in anticipation. Second, if forecasts have to pass through several layers of management, the effect may be to greatly exaggerate the original forecast or to make it ultra-conservative. Third, by focusing explicit attention only on the gloomy outcomes, chances are increased for passing by some good investments.
19. Risk-adjusted Discount Rate Vs. Certainty–Equivalent The certainty—equivalent approach recognises risk in capital budgeting analysis by adjusting estimated cash flows and employs risk-free rate to discount the adjusted cash flows. On the other hand, the risk-adjusted discount rate adjusts for risk by adjusting the discount rate. It has been suggested that the certainty—equivalent approach is theoretically a superior technique. The risk-adjusted discount rate approach will yield the same result as the certainty—equivalent approach if the risk-free rate is constant and the risk-adjusted discount rate is the same for all future periods.
20. Sensitivity Analysis Sensitivity analysis is a way of analysing change in the project’s NPV (or IRR) for a given change in one of the variables. The decision maker, while performing sensitivity analysis, computes the project’s NPV (or IRR) for each forecast under three assumptions: (a) pessimistic, (b) expected, and (c) optimistic.
21. Sensitivity Analysis? It compels the decision-maker to identify the variables, which affect the cash flow forecasts. This helps him in understanding the investment project in totality. It indicates the critical variables for which additional information may be obtained. The decision-maker can consider actions, which may help in strengthening the ‘weak spots’ in the project. It helps to expose inappropriate forecasts, and thus guides the decision-maker to concentrate on relevant variables. It does not provide clear-cut results. The terms ‘optimistic’ and ‘pessimistic’ could mean different things to different persons in an organisation. Thus, the range of values suggested may be inconsistent. It fails to focus on the interrelationship between variables. For example, sale volume may be related to price and cost. A price cut may lead to high sales and low operating cost.
22. Scenario Analysis One way to examine the risk of investment is to analyse the impact of alternative combinations of variables, called scenarios, on the project’s NPV (or IRR). The decision-maker can develop some plausible scenarios for this purpose. For instance, we can consider three scenarios: pessimistic, optimistic and expected.
23. Simulation Analysis The Monte Carlo simulation simulation analysis considers the interactions among variables and probabilities of the change in variables. It computes the probability distribution of NPV. The simulation analysis involves the following steps: First, you should identify variables that influence cash inflows and outflows. Second, specify the formulae that relate variables. Third, indicate the probability distribution for each variable. Fourth, develop a computer programme that randomly selects one value from the probability distribution of each variable and uses these values to calculate the project’s NPV.
24. Rajshree Ltd. an existing profit-making company is planning to introduce a new product with a projected life of 5 years. The plan is to produce 1.5 lakh units each year with a sale price of Rs.118 per unit. The contribution to sales ratio of the new product is 64%. Fixed operating costs excluding depreciation are likely to be Rs.23.28 lakh per annum. The above project will require an initial investment of Rs.180 lakh for the purchase of plant and machinery. The plant and machinery will depreciate at the rate of 15% as per WDV method. Moreover, at the end of five years, the salvage value of the plant and machinery will be 30% of the initial investment. The applicable tax rate to the company is 30%. The company requires a return of 14% after tax on its investment. Indicate the financial viability of the project by calculating the Net Present Value. Determine the Sensitivity of the Project’s NPV under each of the following conditions: § Decrease in selling price by 5%. § Increase in cost of Plant & Machinery by 11% and net salvage value of Plant and Machinery by Rs.5.94 lakh
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26. Shortcomings The model becomes quite complex to use. It does not indicate whether or not the project should be accepted. Simulation analysis, like sensitivity or scenario analysis, considers the risk of any project in isolation of other projects.
27. Decision Trees -Sequential Investment Decisions Investment expenditures are not an isolated period commitments, but as links in a chain of present and future commitments. An analytical technique to handle the sequential decisions is to employ decision trees.
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29. Usefulness of Decision Tree Approach It clearly brings out the implicit assumptions and calculations for all to see, question and revise. It allows a decision maker to visualise assumptions and alternatives in graphic form, which is usually much easier to understand than the more abstract, analytical form. The decision tree diagrams can become more and more complicated as the decision maker decides to include more alternatives and more variables and to look farther and farther in time. It is complicated even further if the analysis is extended to include interdependent alternatives and variables that are dependent upon one another.
30. Utility Theory and Capital Budgeting Utility theory aims at incorporation of decision-maker’s risk preference explicitly into the decision procedure. As regards the attitude of individual investors towards risk, they can be classified in three categories: Risk-averse Risk-neutral Risk-seeking Individuals are generally risk averters and demonstrate a decreasing marginal utility for money function.
31. Let us assume that the owner of a firm is considering an investment project, which has 60 per cent of probability of yielding a net present value of Rs 10 lakh and 40 per cent probability of a loss of net present value of Rs 10 lakh. Project has a positive expected NPV of Rs 2 lakh. However, the owner may be risk averse, and he may consider the gain in utility arising from the positive outcome (positive PV of Rs 10 lakh) less than the loss in utility as a result of the negative outcome (negative PV of Rs 10 lakh). The owner may reject the project in spite of its positive ENPV.
32. Benefits and Limitations of Utility Theory First, the risk preferences of the decision-maker are directly incorporated in the capital budgeting analysis. Second, it facilitates the process of delegating the authority for decision. Difficulties are encountered in specifying a utility function. Second, even if the owner’s or a dominant shareholder’s utility function be used as a guide, the derived utility function at a point of time is valid only for that one point of time. Third, it is quite difficult to specify the utility function if the decision is taken by a group of persons.