Chapter 8 Capital Budgeting Decision Criteria8章资本预算决策标准.docx
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Chapter 8 Capital Budgeting Decision Criteria8章资本预算决策标准.docx
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Chapter8CapitalBudgetingDecisionCriteria8章资本预算决策标准
Chapter11:
TheBasicsofCapitalBudgeting
I.WhatisCapitalBudgeting?
Theprocessofdeterminingwhatcapitalprojectstoaccept
ProjectClassificationisthestartingpointfordeterminingtheappropriatediscountrate
Replacementtomaintaincurrentoperations
Replacementtoreducecosts
Expansionofexistingproductsormarkets
Expansionintonewproductsormarkets
Pureresearch&development(example:
pharmaceuticalfirms)
Exploration(example:
energyfirms)
Safetyand/orenvironmental(governmentmandated)projects
II.DecisionCriteria
Whatarethemajorinvestmentdecisioncriteria?
NetPresentValue-NPV
InternalRateofReturn-IRR
ModifiedInternalRateofReturn-MIRR
PaybackPeriod-Payback
DiscountedPaybackPeriod–DiscountedPayback
ProfitabilityIndex-PI
Whataretheyusedfor?
Toevaluatethecashflowsfromcapitalinvestmentprojects
Tomaketheacceptorrejectdecision
A.TheNPVRule:
1.WhyIsNetPresentValuetheBestDecisionCriteria?
-Itconsidersthetimevalueofmoney(TVM)…adollartodayisworthmorethanadollarinthefuture
-Itconsidersallcashflowsduringtheproject’sentirelife
-NPVletsyouknowexactlyhowmuchvalueisbeingaddedbytheproject
-Youcansettheappropriaterequirerateofreturn(discountrateorhurdlerate)dependingonaproject’srisk
2.CalculatingNetPresentValue(NPV:
NPV=CF0+CF1+CF2+...+CFt
(1+r)1(1+r)2(1+r)t
3.TheNPVdecision(accept/reject)rule:
-Accepttheproject(investment)ifNPV>zero
-RejecttheprojectifNPV 4.WhatdoesapositiveNPVmean? -ThePVofcashinflows>PVofcashoutflows -ThevalueofthecompanyisbeingincreasedbytheamountofNPV -Theprojectmeetstherequiredrateofreturn…andthensome NPVExample1: Afriendasksyoutoinvest$20,000andpromisestopayyou$26,000attheendof2years.Yourrequiredrateofreturnis15%.Doyoutaketheoffer? NPV=CF0+CF2 (1+r)2 NPV=-20,000+26,000=>-20,000+19,660 1.152 NPV=$-340Youshouldrejectyourfriend’soffer! *Ifthiswereacapitalinvestmentproject,acceptancewouldreducethevalueofthecompanyby$340! *Acceptanceoftheprojectwouldnotincreasethevalueofthecompanyby$6,000! Thekeyvariablehereistherequiredrateofreturn(ordiscountrate). Therequiredrateofreturn(RRR)is: *Thehurdlerate *Thecostofcapital(funds) *Thebestrateofreturnthecompanycouldexpectonotherprojectsofsimilarrisk Note: Inacompetitivemarket,positiveNPVprojectsareconsideredrareandrequirediligentefforttouncover NPVExample2: Twoprojectswithidenticalcashoutflows(investment=$1,000)butdifferenttimingofcashinflows.Discountrate=10% NPVforprojectS: (Largecashinflowscomesooner) 01234 |---------------|---------------|---------------|--------------| NetCF-1,000500400300100 NPV(S)=$78.82 NPVforprojectL: (Largecashinflowscomelater) 01234 |---------------|---------------|---------------|--------------| NetCF-1,000100300400500 NPV(L)=-$19.12 B.ThePaybackRule: Timeperiodrequiredforaprojecttogenerateenoughcashinflowstorecovertheinitialcost. ThePaybackdecision(accept/reject)rule: -Acceptifpaybackperiod -Rejectifpaybackperiod>maximumacceptablepaybackperiod. Advantages -Easytounderstand: theshorterthepaybackperiod,thebetter -Quickindicatoroftheliquidityriskoftheproject(howlongfundswillbetiedup) Disadvantages -Ignorestimevalueofmoney -Ignorescashflowsbeyondacceptablepaybackdate -Acceptablepaybackdateisusuallyanarbitrarycutoffpoint.Riskisnotquantifiedinarequiredrateofreturn.Theliquidityriskissimplya“ruleofthumb” ProjectS: 01234 |---------------|---------------|---------------|---------------| NetCF-1,000500400300100 Cumulative-1,000-500-100200300 NCF Payback=yearsbefore+uncoveredcostatendofyear fullrecoveryNCFduringfollowingyear =2+100/300 =2.33years Ifacceptablepaybackperiodis2.33ormoreyears,youacceptprojectS C.TheDiscountedPaybackRule: Timeperiodrequiredforaprojecttogenerateenoughdiscountedcashinflowstorecovertheinitialcost. TheDiscountedPaybackdecision(accept/reject)rule: -Acceptifdiscountedpaybackperiod -Rejectifdiscountedpaybackperiod>maximumacceptablepaybackperiod. Advantages -Easytounderstand: theshorterthepaybackperiod,thebetter -Quickindicatoroftheliquidityriskoftheproject(howlongfundswillbetiedup) -Doesconsiderthetimevalueofmoney Disadvantages -Ignorescashflowsbeyondacceptablepaybackdate -Acceptablepaybackdateisusuallyanarbitrarycutoffpoint. ProjectS: Assumea10percentdiscountrate 01234 |---------------|---------------|---------------|---------------| NetCF-1,000500400300100 PVNCF-1,00045433122568 Cumulative-1,000-546-21510 PVNCF Payback=yearsbefore+uncoveredcostatendofyear fullrecoveryNCFduringfollowingyear =2+215/225 =2.96years Ifacceptablepaybackperiodis2.96ormoreyears,youacceptprojectS D.InternalRateofReturn TheIRRissimilartoabond’syieldtomaturity.Itistheratethatmakesthepresentvalueofcashinflows(CIF)equaltothepresentvalueofcashoutflows(COF).Thus,itistherateofreturnthatresultsinazeroNPVwhenitisusedasthediscountrate. NPV=CF0+CF1+CF2+...+CFt (1+r)1(1+r)2(1+r)t 0=CF0+CF1+CF2+...+CFt (1+IRR)1(1+IRR)2(1+IRR)t IRRDecisionRule -AccepttheprojectifIRR>req’drateofreturn(discountrate) -RejecttheprojectifIRR Advantages -ConsidersTVM -Considersallcashflows -Easytounderstand Disadvantages -Mayuseunreasonablediscountrate -CanconflictwithNPVifprojectsaremutuallyexclusive IRRExamples: IRRforProjectS 01234 ProjectS|---------------|---------------|---------------|---------------| -1,000500400300100 0=-1000+500+400+300+100 (1+Irr)1(1+Irr)2(1+Irr)3(1+Irr)4 SolvefortheIRR.Thatisthediscountratethatsolvesthisequationandmakestheanswer(NPV)equaltozero. IRRforProjectS=14.49% IRRforProjectL 01234 ProjectL|---------------|---------------|---------------|----------------| -1,000100300400500 0=-1000+100+300+400+500 (1+Irr)1(1+Irr)2(1+Irr)3(1+Irr)4 IRRforProjectL=9.27% TheIRRisthemostpopularmethod,afterNPV,forevaluatingcashflowsandisalmostasgood. ProblemswithIRR: ThereareproblemswithusingIRRratherthanNPVwithyouarechoosingbetweenmutuallyexclusiveprojects: -Independentprojects: Whenevaluatingmultipleprojectsandany,none,orallofthemcanbeaccepted.Acceptanceofanyprojecthasnobearingontheacceptanceorrejectionofanother. -Mutuallyexclusiveprojects: Whenevaluatingmultipleprojectsandonlyonecanbeaccepted.Acceptanceofoneprojectmeansrejectionoftheother(s). ThereisneveraconflictbetweenIRRandNPVcriterionwhenevaluatingindependentprojects.Butwhenchoosingbetweenmutuallyexclusiveprojects,theIRRchoicemayconflictwiththeNPVchoiceundercertainconditions. TheScaleProblem: Apotentialconflictexistswhentherearesignificantdifferencesinthesizeofthecashflows.Anexamplewouldbeifcomparingaprojectwitha$100,000initialinvestment(COF)withanotherprojectwitha$1,000,000initialinvestment. TheTimingProblem: Apotentialconflictexistswhenthetimingofthecashflowsfortwoprojectsareradicallydifferent.ThiscanresultinaconflictbetweentheNPVchoiceandtheIRRchoiceatlowdiscountrates. MultipleIRRs: Projectswithnon-normal(non-conventional)cashflowsmayhavemultipleIRRs.Anormal(orconventional)cashflowisacashoutflowatthebeginningofaproject,followedbycashinflowsthereafter. TheNPVProfile: NPVgraphedagainstthediscountrate RecalltheNPV&IRRacceptancerules: NPV: AccepttheprojectifNPV>zero IRR: AccepttheprojectifIRR>RRR NPV CashFlows -1000 $300500 400 300 100 IRR 0r .1449 AnyprojectwithapositiveNPVwillalsohaveanIRRthatexceedsthediscountrate(requiredrateofreturn). NPVProfilesforMutuallyExclusiveProjects: NPVCashFlows AB ProjectB-10,000-10,000 10,0001,000 1,0001,000 1,00012,000 Crossoverrate ProjectA r Example: IRRvsNPVforMutualExclusiveProjects CashFlows AB -10,000-10,000 10,0001,000 1,0001,000 1,00012,000 IRRforA_____________IRRforBis___________ NPVat0%____________NPVat0%____________ NPVat10%___________NPVat10%___________ NPVat15%___________NPVat15%___________ Whichprojectisacceptableiftheyareindependent? Why? Whichprojectisacceptableiftheyaremutuallyexclusive? Why? E.ModifiedInternalRateofReturn -AccepttheprojectifMIRR>req’drateofreturn(di
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