FARM MANAGEMENT

WK 5: CAPITAL BUDGETS

(INVESTMENT ANALYSIS)

MM WATERLOO

FARM MTG CONCEPTS

WK 1: INTRODUCTION

WK 2: ECONOMICS & FARM RECORDS

WK 3: BUDGETS

WK 4: WHOLE FARM BUDGETS

WK 5: CAPITAL BUDGETSWK 6: MACHINERY MANAGEMENT

WK 7: LAND MANAGEMENT

WK 8: CREDIT MANAGEMENT

WK 9: HUMAN RESOURCE MANAGEMENT

WK 10: SUCCESSION MANAGEMENT

TEXT BOOK READING ON CAPITAL BUDGETING

FARM MANAGEMENT, 4th EdKAY & EDWARDS

CHAP 17: PG 309-332

WK 5: CAPITAL BUDGETS

DISCUSSION POINTSI. INTRODUCTIONII. CAPITAL BUDGET STEPSIII. NON-TIME METHODS A. PAYBACK B. ACCT RATE OF RETURN

C. BOOK RATE OF RETURNIV. SUMMARY

WK 5: CAPITAL BUDGETS

V. TIME METHOD A. TIME VALUE OF MONEY B. NET PRESENT VALUE METHOD C. BENEFIT COST RATIO D. INTERNAL RATE OF RETURN E. SUMMARY

I. INTRODUCTION

A. DEFINITION: ALLOCATION OF RESOURCES FOR MAJOR AND/OR LONG TERM PROJECTS

B. ASSUMPTIONS

1. UNLIMITED PROJECTS

2. LIMITED RESOURCES

WK 5: CAPITAL BUDGETS

IV. TIME VALUE OF MONEY

YEAR 1: $100 * .10 * 1 YR = $110.00

YEAR 2: $110 * .10 * 1YR = $121.00

YEAR 3: $121 * .10 * 1 YR = $133.10

LUMP SUM

INVESTMENT

$100

1st YR INTEREST

10% * 100 = $10

2nd YR INTEREST

10% *(100+10) = $11

3rd YR INTEREST

10% *(100+10+11)=12

A. FUTURE VALUE (COMPOUNDING) 1. ...OF A LUMP SUM

FUT VAL = LUMP SUM*(1+i)N

=$100 *(1+.10)3

= $133.00

2. …OF A YR END ANNUITY END 1st YR; $100 * (1+ .1)2 = $121.00 END OF 3rd YR

END 2nd YR; $100 * (1 + .1)1 = $110.00 END OF 3rd YR

END 3rd YR; $100 * (1 + .1)0 = $100.00 END OF 3rd YR

$331.00 $331

YR 1

INVEST

$100

YR 2 INT

$10

YR 3 INT

$11

YR 2

INVEST

$100

YR 3

INVEST

$100

YR 3 INT

$10

=

FUT VAL = INV STREAM*(1 + i)N -1

i

B. PRESENT VALUE (DISCOUNTING) 1. ... OF A FUTURE LUMP SUM

PRES VAL (@10%) OF $ 100 RECEIVED 3 YR FROM NOW?

PRES VAL = FUTURE VALUE *[ 1/((1+.1)N)]

PRES VAL = 100 *[1/(1 + .1)3] = $75.13

PROOF: $75.13*(1 + .1)3 = $99.998

$ ?

LUMP

SUM

$82.60

$100

FUTURE VALUE

IN

3 YRS$75.13

$90.01$8.31$7.47

$9.09

2. .... OF AN INVESTMENT STREAMEND 1st YR; $100 * .909 = $90.90 (PRES VAL)

END 2nd YR; $100 * .826 = $82.60 (PRES VAL)

END 3rd YR; $100 * .751 = $75.10 (PRES VAL)

$248.60

$248.60 IS MAX TO PAY FOR INVEST THAT PAYS $100/YR ANNUITY @ 10% INTEREST

PRES VAL = INV STRM*[1-(1 + i)-N ]/i

$75.13

PRES

VAL

$82.60

PRES

VAL

$90.91

PRES VAL

$9.09

$7.47

$8.31

$9.09

$8.31

$9.09$248.60

$75.13

+

82.60

+

$90.91

PRESENT VALUE AT 10% TO

GIVE $100 A YR FOR 3

YRS =

IV. PRESENT VALUE METHODSA. NET PRESENT VAL & BENEFIT/COST

1. ADVANTAGES

a. CONSIDERS TIME VAL OF $

b. FOCUS ON CASH FLOWS

2. DISADVANTAGES

a. MORE COMPLEX CALCULATIONS

b. ASSUMES REINVESTMENT AT

RATE OF RETURN

B. NET PRESENT VAL CALCULATION

INVESTMENT

CASH FLOW 1

CASH FLOW 2

CASH FLOW 3

CASH FLOW 4

CASH FLOW 5

SALVAGE VAL

LUMP

$10,000TABLE 2:

10%

PRESENT VALUE

-INVESTMENT

NET PRESENT VALUE

PRES VAL

$9,315

0.9090.826

0.751

0.683

$0$0

$0

$0

$15,000

$0

$0

$0$0

0.621 9,315

(685)

-10,000

INVESTMENT

CASH FLOW 1

CASH FLOW 2

CASH FLOW 3

CASH FLOW 4

CASH FLOW 5

SALVAGE VAL

EQUAL

$48,000

$10,000

$10,000

$10,000

$10,000

$10,000

TABLE 2: 10%

PRESENT VALUE

-INVESTMENT

NET PRESENT VALUE

PRES VAL

9,090

8,260

7,510

6,830

6,210

37900

$37,900

-$48,000

($10,100)

0.621

[3.790]

0.683

0.751

0.8260.909

INVESTMENT

CASH FLOW 1

CASH FLOW 2

CASH FLOW 3

CASH FLOW 4

CASH FLOW 5

SALVAGE VAL

UNEQUAL

$4,000

$2,000

$2,000

$3,000

TABLE 2: 10%

0.909

0.826

0.751

PRESENT VALUE

-INVESTMENT

NET PRESENT VALUE

PRES VAL

1,818

1,652

2,253

5,723

$5,723

-$4,000

$1,723

B. BENEFIT- COST CALCULATION

INVESTMENT

CASH FLOW 1

CASH FLOW 2

CASH FLOW 3

CASH FLOW 4

CASH FLOW 5

SALVAGE VAL

LUMP

$10,000

$0

$0

$0

$0

$15,000

EQUAL

$48,000

$10,000

$10.000

$10,000

$10,000

$10,000

PRESENT VALUE

INVESTMENT

BENEFIT/COST =

UNEQUAL

$4,000

$2,000

$2,000

$3,000

9,315

10,000

37,900

48,000

5,723

4,000

1.43 .790 .932

1. ADVANTAGES

a. CONSIDERS ALL CASH FLOWS

b. PROVIDES BASE FOR COMPARISON

2. DISADVANTAGE

a. MOST COMPLEX

b. ASSUMES REINVESTMENT AT

INTERNAL RATE OF RETURN

B. INTERNAL RATE OF RETURN

3. INTERNAL RATE OF RET

1. USE PAYBACK PERIOD

2. FIND APPROP ROW IN TABLE1

3. GO ACROSS TO FIND PAYBACK

4. READ UP TO FIND % RET

LUMP

4.66

5 YR

X.XX -

XX.X

3 - 4 %

EQUAL

4.8

5 YR

X.XX -

X.XX

3 - 4%

UNEQUAL

2.0

5 YR

X.XX -

X.XX

3- 4%

TIME SUMMARY

NET PRES VALUE

BENEFIT COST

INTERNAL

RATE

LUMP EQUAL UNEQUAL

$-685 $-10,100 $1,723

.932 .790 1.43

XX% % %

WK 5: CAPITAL BUDGETS

SUMMARY1. CAPITAL BUDGETING LOOKS AT THE

PROFITABILITY OF LG. INVESTMENTS

2. RESULTS OF “NON-TIME” METHODS ( PAYBACK, ACCT RATE OF RET, & BOOK RATE OF RETURN) CAN NOT BE COMPARED TO BANK RATES.

3.RESULTS OF “TIME” METHODS (NET PRESENT VAL, BENEFIT-COST, & INTERNAL RATE OF RET) CAN BE COMPARED TO BANK RATES

WK 5: CAPITAL BUDGETS

ASSOCIATED LABACTIVITIES

CALCULATION OF INVESTMENT MEASURES

-- PAYBACK

-- ACCT RATE OF RETURN

-- BOOK RATE OF RETURN

-- NET PRESENT VALUE

-- BENEFIT/COST

-- INTERNAL RATE OF RET

WK 5: CAPITAL BUDGETS

SELF TESTPRES VAL / INVESTMENT BENEFIT- COST

SIMPLEST METHOD

BUDGET FOR BIG ITEMS

QUANTATIVE BASIS

NON-TIME METHOD W/O SALV

COMPARED TO BANK RATES

IMAGE, PRETIGE

NON-TIME METHOD WITH SALV

TIME TO RECOVER INVESTMENT

PRES VAL - INVESTMENT

PAYBACK

CAPITAL

“WILL IT PAY”

ACCT RATE

TIME METHODS

QUALITATIVE BASIS

BOOK RATE

PAYBACK

NET PRES VAL

EVALUATION

YOUR UNDERSTANDING OF THESE CAPITAL BUDGET CONCEPTS WILL EVALUATED ON THE MIDTERM TO BE GIVEN THE FIFTH FRIDAY OF THE QUARTER (THIS WEEK!!!!!!!!)

WK 5: CAPITAL BUDGETS

MIDTERMTHIS FRIDAY !!!!!

PART 1: OBJECTIVE QUESTIONS (T/F, MC, ETC)

10 PTS: WK 1- INTRODUCTION

10 PTS: WK 2- ECONOMICS & RECORDS

10 PTS: WK 3- BUDGETS (CASH, ENT, ETC)

10 PTS: WK 4- LINEAR PROGRAMMING

10 PTS: WK 5- CAPITAL BUDGETS

PART II. PROBLEMS

20 PTS: ECONOMICS 5 PTS: BUDGETS

18 PTS: LINEAR PROG 9 PTS: INVESTMENT

NEXT TOPIC

TIMELINESS

INTERNATIONAL HARVERSTER W4

IV. TIME VALUE OF MONEYV. TIME METHODS A. NET PRESENT VALUE

B. BENEFIT COSTC. INTERNAL RATE OF

RETURN