fundamentals of corporate finance chapter 9 making capital investment decisions

Fundamentals of Corporate Finance

Chapter 9

Making Capital Investment Decisions

Overview of Lecture

Corporate Finance in the News

Insert a current news story here to frame the material you will cover in the lecture.

Incremental Cash Flows

The Stand-Alone Principal

Incremental Cash Flows

Incremental Cash Flows

Incremental Cash Flows

Pro Forma Financial Statements

Pro Forma Financial Statements

Pro Forma Financial Statements

Pro Forma Financial Statements

Project Cash Flows

Project Operating Cash Flow (OCF)

Project Operating Cash Flow

Project Value

A Closer Look at Net Working Capital

A Closer Look at Net Working Capital

A Closer Look at Net Working Capital

Example 9.1Cash Collections and Costs

Example 9.1Cash Collections and Costs

Depreciation

Depreciation

Depreciation

20% Reducing Balance:

Example 9.2Reducing Balance Depreciation

Example 9.2Reducing Balance Depreciation

Example: Majestic Mulch and Compost Ltd (MMC)

Example: Majestic Mulch and Compost Ltd (MMC)

Example: Majestic Mulch and Compost Ltd (MMC)

Example: Majestic Mulch and Compost Ltd (MMC)

Example: Majestic Mulch and Compost Ltd (MMC)

Example: Majestic Mulch and Compost Ltd (MMC)

Example: Majestic Mulch and Compost Ltd (MMC)

Example: Majestic Mulch and Compost Ltd (MMC)

Alternative Definitions of Operating Cash Flow

Special Cases of DCF Analysis

Example 9.3To Buy or Not to Buy

Example 9.3To Buy or Not to Buy

Example 9.3To Buy or Not to Buy

At 16 per cent, the NPV is €16,157, so the investment is not attractive. After some trial and error, we find that the NPV is zero when the discount rate is 10.62 per cent, so the IRR on this investment is about 10.6 per cent.

Equivalent Annual Cost (EAC)

Investments of Unequal Lives:The Equivalent Annual Cost Method

Date

Machine

0 1 2 3 4

A €500 €120 €120 €120

B €600 €100 €100 €100 €100

Investments of Unequal Lives: The Equivalent Annual Cost Method

Assuming a discount rate of 10%, NPV is:

What is problematic about this analysis?

2 3

2 3 4

€120 €120 €120

1.1 (1.1) (1.1)

€100 €100 €100 €100

1.1 (1.1) (1.1) (1.1)

Machine : €798.42 = €500 +

Machine : €916.99 = €600 +

A

B

Investments of Unequal Lives:The Equivalent Annual Cost Method

Investments of Unequal Lives: The Equivalent Annual Cost Method

Investments of Unequal Lives: The Equivalent Annual Cost Method

Machine A:

3.10€798.42 = 2.4869

€321.05

C A C

C

Date0 1 2 3

Cash outflows of machine A

€500 €120 €120 €120

Equivalent annual cost of machine A

€321.05 €321.05 €321.05

Investments of Unequal Lives:The Equivalent Annual Cost Method

Machine B:

4.10€916.99 = 3.1699

€289.28

C A C

C

Date

0 1 2 3 4

Cash outflows of machine B €600 €100 €100 €100 €100

Equivalent annual cost of machine B

€289.28

€289.28

€289.28

€289.28

Investments of Unequal Lives: The Equivalent Annual Cost Method

Choose Machine B

Example 9.4Equivalent Annual Costs

Example 9.4Equivalent Annual Costs

Example 9.4Equivalent Annual Costs

Activities for this Lecture

Thank You