chapter 8han
DESCRIPTION
HANTRANSCRIPT
Chapter 8
Textbook:
Fundamentals of Corporate Finance (Hillier cs)
Jan H. Jansen
E-mail: [email protected]
Investment Decision
Nature of an investment decision:
• Investment amount (large amount)
• Expected, Future Cash Flows
– Outflows (Costs)
– Inflows (Revenues)
• Discount factor
– Real interest rate
– Inflation
– Risk
• Economic life vs technical life
• Scrap value / Residual value
Stages in an investment decision
Determine investment
funds available
Identify profitable
project opportunities
Evaluate the proposed
project
Approve the project
Monitor and control the
project
Investment decision criteria
• Payback Period
• Average Accounting Return / ROI
• Net Present Value
• Profitability Index
• Internal Rate of Return / IRR
• Discounted Payback / Break even time
Payback Period
The amount of time required for an
investment to generate cash flows
sufficient to recover its initial cost
Average Accounting Return / ROI
An investment’s average net income
divided by its average book value
Net Present Value (NPV)
NPV
The process of valuing an investment by
discounting its future cash flows
An investment should be accepted if the net
present value is positive and rejected if it is
negative.
Advantages of NPV
Uses Cash Flows
• Cash Flows are better than Earnings (Cash is a fact, profit is an opinion)
Uses all Cash Flows
• Other approaches ignore cash flows beyond a certain date
Discounts Cash Flows
• Fully incorporates the Time Value of Money
Profitability Index
Discounted Payback / Break even time
The length of time required for an
investment’s discounted cash flows
to equal its initial cost
Internal Rate of Return (IRR)
The discount rate (irr) that makes
the NPV of an investment zero
Internal Rate of Return (IRR)
IRR equation: Polynomial (degree of n)
The possibility that more than one
discount rate will make the NPV of an
investment zero
Structure Excel model
Data & Assumptions
Cash Outflows
Cash Inflows
Calculations
Results
How to build an Excel model
– Worksheet 1 (Project name)• Project name
• Version & Date
• Authors
– Worksheet 2 (Results)• Investment amount
• Economic life
• Decision criteria
– Worksheet 3 (Data)• Data
• Assumptions
– Worksheet 4 (COF)• Cash Outflows
– Worksheet 5 (CIF)• Cash Inflows
– Worksheet 6 (NCF)• Net Cash Flows
Investment case
• Investment € 50,000,000
• Scrap value: € 0
• Expected economic life: 10 years
• Expected Real Interest rate: 3%
• Expected Inflation: 2.5%
• Risk mark up: 1.5%
• Annual Revenues: € 10,000,000
• Annual Costs: € 2,000,000
Calculate
• Discount factor
• Payback Period
• Average Accounting Return / ROI
• Net Present Value
• Profitability Index
• Internal Rate of Return / IRR
• Discounted Payback / Break even time
Should we invest or not?
Excel functions
• ^
• COUNTIF
• NPV
• IRR
Results
PBP 7years
ROI 12,0%
NPV € 5.778.955,65
PI 11,56%
IRR 9,6%
BET 9years
Decision criteria: Pro’s & Con’s
• Payback Period
• Average Accounting Return / ROI
• Net Present Value
• Profitability Index
• Internal Rate of Return / IRR
• Discounted Payback / Break even time