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1、Chapter 13,Capital Budgeting Techniques,Capital Budgeting Techniques,Project Evaluation and Selection Potential Difficulties Capital Rationing Project Monitoring Post-Completion Audit,Project Evaluation: Alternative Methods,Payback Period (PBP) Internal Rate of Return (IRR) Net Present Value (NPV) P
2、rofitability Index (PI),Proposed Project Data,Julie Miller is evaluating a new project for her firm, Basket Wonders (BW). She has determined that the after-tax cash flows for the project will be $10,000; $12,000; $15,000; $10,000; and $7,000, respectively, for each of the Years 1 through 5. The init
3、ial cash outlay will be $40,000.,Independent Project,Independent - A project whose acceptance (or rejection) does not prevent the acceptance of other projects under consideration.,For this project, assume that it is independent of any other potential projects that Basket Wonders may undertake.,Payba
4、ck Period (PBP),PBP is the period of time required for the cumulative expected cash flows from an investment project to equal the initial cash outflow.,0 1 2 3 4 5,-40 K 10 K 12 K 15 K 10 K 7 K,(c),10 K 22 K 37 K 47 K 54 K,Payback Solution (#1),PBP = a + ( b - c ) / d = 3 + (40 - 37) / 10 = 3 + (3)
5、/ 10 = 3.3 Years,0 1 2 3 4 5,-40 K 10 K 12 K 15 K 10 K 7 K,Cumulative Inflows,(a),(-b),(d),Payback Solution (#2),PBP = 3 + ( 3K ) / 10K = 3.3 Years Note: Take absolute value of last negative cumulative cash flow value.,Cumulative Cash Flows,-40 K 10 K 12 K 15 K 10 K 7 K,0 1 2 3 4 5,-40 K -30 K -18 K
6、 -3 K 7 K 14 K,PBP Acceptance Criterion,Yes! The firm will receive back the initial cash outlay in less than 3.5 years. 3.3 Years 3.5 Year Max.,The management of Basket Wonders has set a maximum PBP of 3.5 years for projects of this type. Should this project be accepted?,PBP Strengths and Weaknesses
7、,Strengths: Easy to use and understand Can be used as a measure of liquidity Easier to forecast ST than LT flows,Weaknesses: Does not account for TVM Does not consider cash flows beyond the PBP Cutoff period is subjective,Internal Rate of Return (IRR),IRR is the discount rate that equates the presen
8、t value of the future net cash flows from an investment project with the projects initial cash outflow.,CF1 CF2 CFn,(1+IRR)1 (1+IRR)2 (1+IRR)n,+ . . . +,+,ICO =,$15,000 $10,000 $7,000,IRR Solution,$10,000 $12,000,(1+IRR)1 (1+IRR)2,Find the interest rate (IRR) that causes the discounted cash flows to
9、 equal $40,000.,+,+,+,+,$40,000 =,(1+IRR)3 (1+IRR)4 (1+IRR)5,IRR Solution (Try 10%),$40,000 = $10,000(PVIF10%,1) + $12,000(PVIF10%,2) + $15,000(PVIF10%,3) + $10,000(PVIF10%,4) + $ 7,000(PVIF10%,5) $40,000 = $10,000(.909) + $12,000(.826) + $15,000(.751) + $10,000(.683) + $ 7,000(.621) $40,000 = $9,09
10、0 + $9,912 + $11,265 + $6,830 + $4,347 = $41,444 Rate is too low!,IRR Solution (Try 15%),$40,000 = $10,000(PVIF15%,1) + $12,000(PVIF15%,2) + $15,000(PVIF15%,3) + $10,000(PVIF15%,4) + $ 7,000(PVIF15%,5) $40,000 = $10,000(.870) + $12,000(.756) + $15,000(.658) + $10,000(.572) + $ 7,000(.497) $40,000 =
11、$8,700 + $9,072 + $9,870 + $5,720 + $3,479 = $36,841 Rate is too high!,.10 $41,444 .05 IRR $40,000 $4,603 .15 $36,841 X $1,444 .05 $4,603,IRR Solution (Interpolate),$1,444,X,=,.10 $41,444 .05 IRR $40,000 $4,603 .15 $36,841 X $1,444 .05 $4,603,IRR Solution (Interpolate),$1,444,X,=,.10 $41,444 .05 IRR
12、 $40,000 $4,603 .15 $36,841 ($1,444)(0.05) $4,603,IRR Solution (Interpolate),$1,444,X,X =,X = .0157,IRR = .10 + .0157 = .1157 or 11.57%,IRR Acceptance Criterion,No! The firm will receive 11.57% for each dollar invested in this project at a cost of 13%. IRR Hurdle Rate ,The management of Basket Wonde
13、rs has determined that the hurdle rate is 13% for projects of this type. Should this project be accepted?,IRR Strengths and Weaknesses,Strengths: Accounts for TVM Considers all cash flows Less subjectivity,Weaknesses: Assumes all cash flows reinvested at the IRR Difficulties with project rankings an
14、d Multiple IRRs,Net Present Value (NPV),NPV is the present value of an investment projects net cash flows minus the projects initial cash outflow.,CF1 CF2 CFn,(1+k)1 (1+k)2 (1+k)n,+ . . . +,+,- ICO,NPV =,Basket Wonders has determined that the appropriate discount rate (k) for this project is 13%.,$1
15、0,000 $7,000,NPV Solution,$10,000 $12,000 $15,000,(1.13)1 (1.13)2 (1.13)3,+,+,+,- $40,000,(1.13)4 (1.13)5,NPV =,+,NPV Solution,NPV = $10,000(PVIF13%,1) + $12,000(PVIF13%,2) + $15,000(PVIF13%,3) + $10,000(PVIF13%,4) + $ 7,000(PVIF13%,5) - $40,000 NPV = $10,000(.885) + $12,000(.783) + $15,000(.693) + $10,000(.613) + $ 7,
