Lecture 8 (Chapter 11): Project Analysis and Evaluation

Size: px
Start display at page:

Download "Lecture 8 (Chapter 11): Project Analysis and Evaluation"

Transcription

1 Lecture 8 (Chapter 11): Project Analysis and Evaluation Discounted cash flow analysis is a very powerful tool, but it is not easy to use. We have already seen one difficulty: How do we identify the cash flows? Today we begin to focus on a second difficulty: What if our cash flows are not certain? Risk plays a crucial part in DCF analysis. To understand cash fl ow risk, we will use several tools: Scenario analysis Sensitivity analysis Break-even analysis Operating leverage Simulation analysis Lecture 8: Project Analysis and Evaluation 1 Capital Rationing Definition: A situation where a firm has positive NPV projects, but cannot obtain funding to undertake them. Soft Rationing: Firm sets internal limits on capital available to its divisions. Used by firms as an alternative means of controlling investments where DCF is too hard or not understood. Hard rationing: Capital markets refuse to finance the firm. If the firm was willing to pay a high enough rate, could it find someone to invest? If so, perhaps the opportunity cost of capital was calculated incorrectly. If not, perhaps the cash flows are not correct. Market inefficiency (asymmetric information) Lecture 8: Project Analysis and Evaluation 2 1

2 Evaluating NPV Estimates The cash flows that we use in DCF analysis are projections of the future. What will be the effect if these projections turn out to be inaccurate? Forecasting risk: bad projections can lead to bad decisions One way to look for problems in DCF is to ask: Why should we expect this project to have a positive NPV? The project must be better than all the alternatives available to the investor (opportunity cost of capital) Where is the source of value? Innovation, Low cost, Market niche, Economies of scale/scope How competitive is the market? Lecture 8: Project Analysis and Evaluation 3 What-if Analysis What happens if our projections turn out to be wrong? Start with a Base Case that gives our best estimate of the future cash flows. Then vary the cash flows using Scenario analysis: imagine different possible states of the world, and project cash flows and NPVs for each state. Sensitive analysis: change one input variable and see how this affects the resulting NPV. Break-even Analysis: find the value of an input variable (typically sales) that sets the projects NPV to zero Operating Leverage: the degree to which a change in sales impacts the NPV Simulation analysis: use random variables as inputs and calculate NPV many times to determine the distribution of possible NPVs. Lecture 8: Project Analysis and Evaluation 4 2

3 Example Base Case Fairways Driving Range expects rentals to be 20,000 buckets at $3 per bucket. Equipment costs $20,000 and will be depreciated straight-line over 5 years and have a $0 salvage value. Variable costs are 10% of rentals and fixed costs are $45,000 per year. Assume no increase in working capital nor any additional capital outlays. The required return is 15% and the tax rate is 15%. Lecture 8: Project Analysis and Evaluation 5 Scenario Analysis Imagine three states of the world: Base case (our best estimate) Rent 20,000 buckets Variable costs are 10% of revenues Best case (everything works out perfectly) Rent 25,000 buckets Variable costs are 8% of revenues Worst case (nothing goes like it should) Rent 15,000 buckets Variable costs are 12% of revenues How will this change our decision? Lecture 8: Project Analysis and Evaluation 6 3

4 Sensitivity Analysis Change only one input variable at a time and see how the NPV is affected. Find which assumptions are the most important We can then spend more time checking these assumptions Gives us an idea of the riskiness (variability) of our NPV estimate Focus on variables that cannot be directly controlled by the firm to see the effects of nature on our project. For example, try optimistic and pessimistic values. Lecture 8: Project Analysis and Evaluation 7 Break-Even Analysis Find the level of sales that the project must achieve to have a positive NPV Remember finding the bid price from Lecture 7? Set NPV = 0 and solve for sales. Often it won t be so easy to solve by hand. Question: What is the break-even level of the discount rate called? Lecture 8: Project Analysis and Evaluation 8 4

5 Accounting Break-Even Analysis Level of sales that results in zero EBIT and Net Income EBIT = Sales*3*(1-0.1) 45,000 4,000 = 0 Sales = 18,148 General formula: Sales = (FC + Dep)/(Price var cost) Note that when EBIT = 0, Net Income = EBIT*(1-tax) = 0 Accounting break-even < Financial break-even (typically) Ignores time-value of money So NPV < 0 at accounting break-even level of sales What is the IRR? Lecture 8: Project Analysis and Evaluation 9 Cash Break-Even Analysis Level of sales that results in zero yearly cash flow OCF = { [Sales*3(1 0.1) 45,000 4,000]*(1-0.15) + 4,000} = 0 Sales = 16,405 Textbook General formula: Sales = FC/(Price var cost) But this ignores effect of taxes Cash break-even < Accounting break-even < Financial break-even Initial investment completely ignored NPV = -Investment IRR = -100% Cash Break-Even is useful for the treasurer/cash manager to determine working capital needs Lecture 8: Project Analysis and Evaluation 10 5

6 Operating Leverage Degree of Operating Leverage (DOL): The degree to which a change in sales affects Operating Cash Flow Can also be expressed as: the ratio of fixed costs to OCF DOL = 1 + FC/OCF Projects with high operating leverage have high fixed costs and low variable costs Intuition: In a project with high fixed costs and low variable costs, a change in the level of sales will have a large impact on OCF because revenues will increase while costs will stay steady. High operating leverage? riskier OCF Lever Lecture 8: Project Analysis and Evaluation 11 Leverage The Degree of Operating Leverage is often a choice of the firm. High DOL examples: Low DOL examples: A related concept is Financial Leverage : the degree to which changes in EBIT affect earnings. Financial leverage is higher for firms with higher debt loads Changes in revenues have greater effect on shareholders Resulting rate of return is riskier Operating leverage and financial leverage are chosen to compliment each other. Lecture 8: Project Analysis and Evaluation 12 6

7 Simulation Analysis Scenario analysis and sensitivity analysis are both very limited in their ability to reflect all the possible outcomes. Simulation analysis lets us describe possible values of the inputs in a much more complete way (often as random variables), and lets us vary many inputs at the same time. Too difficult to solve analytically Monte Carlo Simulations Sample the input variables many times, and each time calculate the NPV, then analyze the distribution of possible NPVs. Time consuming, so let the computer do it. Lecture 8: Project Analysis and Evaluation 13 Managerial Flexibility (Options) We have imagined the sole job of the manager as a yes/no then wait for the outcome. In reality, managers get the big bucks because they need to be constantly making decisions as the project progresses: Should we wait before deciding Should we expand/contract the project Should we switch inputs Should we abandon the project This flexibility increases the value (and hence the true NPV) of the project Lecture 8: Project Analysis and Evaluation 14 7

8 Valuing Managerial Flexibility Our basic DCF analysis cannot handle decisions made after a project is accepted, but all is not lost. Decision trees: Map out all the possible outcomes and the decisions that we will take in each case, and then value the resulting cash flows. Real Options: Use the techniques developed for financial options (call options, put options, etc), to value options on real assets. These techniques are very powerful and important, but they must await another course. Lecture 8: Project Analysis and Evaluation 15 What we know now DCF analysis is hard: cash flows are not certain. We have techniques for dealing with uncertainty: Scenario analysis: analyze different possible states of the world Sensitivity analysis: Change one input and see the results Break-even analysis: how far can we drop before the project is bad Degree of operating leverage: how are changes in cash flows reflected in earnings Simulation analysis: Allows more complete description of possible future risks Managerial flexibility increases the value of projects Capital rationing is a friction that sometimes prevents the use of DCF analysis Lecture 8: Project Analysis and Evaluation 16 8

Finance for Cultural Organisations Lecture 9. Capital Budgeting: Project Analysis and Evaluation

Finance for Cultural Organisations Lecture 9. Capital Budgeting: Project Analysis and Evaluation Finance for Cultural Organisations Lecture 9. Capital Budgeting: Project Analysis and Evaluation Lecture 9. Capital Budgeting: Project Analysis & Evaluation Understand forecasting risk and sources of value

More information

Chapter. Project Analysis and Evaluation. McGraw-Hill/Irwin. Copyright 2006 by The McGraw-Hill Companies, Inc. All rights reserved.

Chapter. Project Analysis and Evaluation. McGraw-Hill/Irwin. Copyright 2006 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 11 Project Analysis and Evaluation McGraw-Hill/Irwin Copyright 2006 by The McGraw-Hill Companies, Inc. All rights reserved. Key Concepts and Skills Understand forecasting risk and sources of value

More information

11.3 BREAK-EVEN ANALYSIS. Fixed and Variable Costs

11.3 BREAK-EVEN ANALYSIS. Fixed and Variable Costs 385 356 PART FOUR Capital Budgeting a large number of NPV estimates that we summarize by calculating the average value and some measure of how spread out the different possibilities are. For example, it

More information

Chapter 011 Project Analysis and Evaluation

Chapter 011 Project Analysis and Evaluation Multiple Choice Questions 1. Forecasting risk is defined as the: a. possibility that some proposed projects will be rejected. b. process of estimating future cash flows relative to a project. C. possibility

More information

Project cash flows and NPVs may be estimated under different assumptions to improve the decision process.

Project cash flows and NPVs may be estimated under different assumptions to improve the decision process. FIN 301 Class Notes Chapter 9: Project Analysis WHAT-IF Analysis Project cash flows and NPVs may be estimated under different assumptions to improve the decision process. Sensitivity Analysis A. Changing

More information

Session #5 Capital Budgeting - II Damodaran - Chapter 9: 6,12,16,18 Chapter 10: 2,10,16(a&b) Chapter 11: 6,12,14

Session #5 Capital Budgeting - II Damodaran - Chapter 9: 6,12,16,18 Chapter 10: 2,10,16(a&b) Chapter 11: 6,12,14 Session #5 Capital Budgeting - II Damodaran - Chapter 9: 6,12,16,18 Chapter 10: 2,10,16(a&b) Chapter 11: 6,12,14 I. Additional Issues in Capital Budgeting. A. Capital rationing: Use profitability index

More information

Chapter 11 Cash Flow Estimation and Risk Analysis ANSWERS TO SELECTED END-OF-CHAPTER QUESTIONS

Chapter 11 Cash Flow Estimation and Risk Analysis ANSWERS TO SELECTED END-OF-CHAPTER QUESTIONS Chapter 11 Cash Flow Estimation and Risk Analysis ANSWERS TO SELECTED END-OF-CHAPTER QUESTIONS 11-1 a. Cash flow, which is the relevant financial variable, represents the actual flow of cash. Accounting

More information

Chapter 9. Project Analysis

Chapter 9. Project Analysis Chapter 9 Project Analysis 9-2 Topics Covered How Firms Organize the Investment Process Some what if Questions Sensitivity Analysis Scenario Analysis Break Even Analysis Real Options and the Value of Flexibility

More information

CHAPTER 14 COST OF CAPITAL

CHAPTER 14 COST OF CAPITAL CHAPTER 14 COST OF CAPITAL Answers to Concepts Review and Critical Thinking Questions 1. It is the minimum rate of return the firm must earn overall on its existing assets. If it earns more than this,

More information

CHAPTER 10: UNCERTAINTY AND RISK IN CAPITAL BUDGETING: PART I

CHAPTER 10: UNCERTAINTY AND RISK IN CAPITAL BUDGETING: PART I CHAPTER 10: UNCERTAINTY AND RISK IN CAPITAL BUDGETING: PART I 10-1 Year ATCF 0-2,500,000 Initial Investment = $2,500,000 1 $1,280,000 Annual Operating Cash Flows 2 $1,280,000 Revenues $5,000,000 3 $1,280,000

More information

Homework #3 BUSI 408 Summer II 2013

Homework #3 BUSI 408 Summer II 2013 Homework #3 BUSI 408 Summer II 2013 This assignment is due 12 July 2013 at the beginning of class. Answer each question with numbers rounded to two decimal places. For relevant questions, identify the

More information

CHAPTER 9 NET PRESENT VALUE AND OTHER INVESTMENT CRITERIA

CHAPTER 9 NET PRESENT VALUE AND OTHER INVESTMENT CRITERIA CHAPTER 9 NET PRESENT VALUE AND OTHER INVESTMENT CRITERIA Basic 1. To calculate the payback period, we need to find the time that the project has recovered its initial investment. After two years, the

More information

Capital Budgeting. Financial Modeling Templates

Capital Budgeting. Financial Modeling Templates Financial Modeling Templates http://spreadsheetml.com/finance/capitalbudgeting.shtml Copyright (c) 2009-2014, ConnectCode All Rights Reserved. ConnectCode accepts no responsibility for any adverse affect

More information

Pro Forma Income Statements Sales $50,000 Var. costs 30,000 Fixed costs 5,000 Depreciation 7,000 EBIT $8,000 Taxes (34%) 2,720 Net income $5,280

Pro Forma Income Statements Sales $50,000 Var. costs 30,000 Fixed costs 5,000 Depreciation 7,000 EBIT $8,000 Taxes (34%) 2,720 Net income $5,280 Project Analysis: Suppose we want to prepare a set of pro forma financial statements for a project for Norma Desmond Enterprises. In order to do so, we must have some background information. In this case,

More information

Chapter 18. Web Extension: Percentage Cost Analysis, Leasing Feedback, and Leveraged Leases

Chapter 18. Web Extension: Percentage Cost Analysis, Leasing Feedback, and Leveraged Leases Chapter 18 Web Extension: Percentage Cost Analysis, Leasing Feedback, and Leveraged Leases Percentage Cost Analysis Anderson s lease-versus-purchase decision from Chapter 18 could also be analyzed using

More information

CHAPTER 11. Proposed Project. Incremental Cash Flow for a Project. Treatment of Financing Costs. Estimating cash flows:

CHAPTER 11. Proposed Project. Incremental Cash Flow for a Project. Treatment of Financing Costs. Estimating cash flows: CHAPTER 11 Cash Flow Estimation and Risk Analysis Estimating cash flows: Relevant cash flows Working capital treatment Inflation Risk Analysis: Sensitivity Analysis, Scenario Analysis, and Simulation Analysis

More information

Chapter 11 Cash Flow Estimation and Risk Analysis

Chapter 11 Cash Flow Estimation and Risk Analysis Chapter 11 Cash Flow Estimation and Risk Analysis ANSWERS TO END-OF-CHAPTER QUESTIONS 11-1 a. Cash flow, which is the relevant financial variable, represents the actual flow of cash. Accounting income,

More information

CHAPTER 12 RISK, COST OF CAPITAL, AND CAPITAL BUDGETING

CHAPTER 12 RISK, COST OF CAPITAL, AND CAPITAL BUDGETING CHAPTER 12 RISK, COST OF CAPITAL, AND CAPITAL BUDGETING Answers to Concepts Review and Critical Thinking Questions 1. No. The cost of capital depends on the risk of the project, not the source of the money.

More information

Will the future benefits of this project be large enough to justify the investment given the risk involved?

Will the future benefits of this project be large enough to justify the investment given the risk involved? Chapter 1 The Overall Process Capital Expenditures Whenever we make an expenditure that generates a cash flow benefit for more than one year, this is a capital expenditure. Examples include the purchase

More information

Cash Flow, Taxes, and Project Evaluation. Remember Income versus Cashflow

Cash Flow, Taxes, and Project Evaluation. Remember Income versus Cashflow Cash Flow, Taxes, and Project Evaluation Of the four steps in calculating NPV, the most difficult is the first: Forecasting cash flows. We now focus on this problem, with special attention to What is cash

More information

Things to Absorb, Read, Do

Things to Absorb, Read, Do McGraw-Hill/Irwin Copyright 2012 by The McGraw-Hill Companies, Inc. All rights reserved. Things to Absorb, Read, Do Need to Absorb - There are three important areas in this chapter; decision trees, sensitivity/

More information

Which projects should the corporation undertake

Which projects should the corporation undertake Which projects should the corporation undertake Investment criteria 1. Investment into a new project generates a flow of cash and, therefore, a standard DPV rule should be the first choice under consideration.

More information

Chapter 9 Making Capital Investment Decisions Introduction

Chapter 9 Making Capital Investment Decisions Introduction Chapter 9 Making Capital Investment Decisions Introduction The cash flows that should be included in a capital budgeting analysis are those that will only occur if the project is accepted These cash flows

More information

Strategy and Analysis in Using NPV. How Positive NPV Arises

Strategy and Analysis in Using NPV. How Positive NPV Arises Strategy and Analysis in Using NPV (Text reference: Chapter 8) Topics how positive NPV arises decision trees sensitivity analysis scenario analysis break-even analysis investment options AFM 271 - Strategy

More information

DUKE UNIVERSITY Fuqua School of Business. FINANCE 351 - CORPORATE FINANCE Problem Set #7 Prof. Simon Gervais Fall 2011 Term 2.

DUKE UNIVERSITY Fuqua School of Business. FINANCE 351 - CORPORATE FINANCE Problem Set #7 Prof. Simon Gervais Fall 2011 Term 2. DUKE UNIVERSITY Fuqua School of Business FINANCE 351 - CORPORATE FINANCE Problem Set #7 Prof. Simon Gervais Fall 2011 Term 2 Questions 1. Suppose the corporate tax rate is 40%, and investors pay a tax

More information

MODULE 2. Capital Budgeting

MODULE 2. Capital Budgeting MODULE 2 Capital Budgeting Capital Budgeting is a project selection exercise performed by the business enterprise. Capital budgeting uses the concept of present value to select the projects. Capital budgeting

More information

Financial and Cash Flow Analysis Methods. www.project-finance.com

Financial and Cash Flow Analysis Methods. www.project-finance.com Financial and Cash Flow Analysis Methods Financial analysis Historic analysis (BS, ratios, CF analysis, management strategy) Current position (environment, industry, products, management) Future (competitiveness,

More information

Chapter 13 Capital Budgeting: Estimating Cash Flow and Analyzing Risk ANSWERS TO END-OF-CHAPTER QUESTIONS

Chapter 13 Capital Budgeting: Estimating Cash Flow and Analyzing Risk ANSWERS TO END-OF-CHAPTER QUESTIONS Chapter 13 Capital Budgeting: Estimating Cash Flow and Analyzing Risk ANSWERS TO END-OF-CHAPTER QUESTIONS 13-3 Since the cost of capital includes a premium for expected inflation, failure to adjust cash

More information

Course 3: Capital Budgeting Analysis

Course 3: Capital Budgeting Analysis Excellence in Financial Management Course 3: Capital Budgeting Analysis Prepared by: Matt H. Evans, CPA, CMA, CFM This course provides a concise overview of capital budgeting analysis. This course is recommended

More information

Part 7. Capital Budgeting

Part 7. Capital Budgeting Part 7. Capital Budgeting What is Capital Budgeting? Nancy Garcia and Digital Solutions Digital Solutions, a software development house, is considering a number of new projects, including a joint venture

More information

Understanding Financial Management: A Practical Guide Guideline Answers to the Concept Check Questions

Understanding Financial Management: A Practical Guide Guideline Answers to the Concept Check Questions Understanding Financial Management: A Practical Guide Guideline Answers to the Concept Check Questions Chapter 8 Capital Budgeting Concept Check 8.1 1. What is the difference between independent and mutually

More information

Capital Budgeting continued: Overview:(1) Estimating cash flows (2) CB examples (3) Dealing with uncertainty of cash flows

Capital Budgeting continued: Overview:(1) Estimating cash flows (2) CB examples (3) Dealing with uncertainty of cash flows Capital Budgeting continued: Overview:(1) Estimating cash flows (2) CB examples (3) Dealing with uncertainty of cash flows Chapter 7: 1,5,7,8,27,32 Chapter 8: 1,3,5,8,13 (clarification for problem 13b:

More information

(Relevant to AAT Examination Paper 4 Business Economics and Financial Mathematics)

(Relevant to AAT Examination Paper 4 Business Economics and Financial Mathematics) Capital Budgeting: Net Present Value vs Internal Rate of Return (Relevant to AAT Examination Paper 4 Business Economics and Financial Mathematics) Y O Lam Capital budgeting assists decision makers in a

More information

ADVANCED INVESTMENT APPRAISAL

ADVANCED INVESTMENT APPRAISAL RELEVANT TO ACCA QUALIFICATION PAPER F9 Studying Paper F9? Performance objectives 15 and 16 are relevant to this exam Investment appraisal is one of the eight core topics within Paper F9, Financial Management

More information

On the Applicability of WACC for Investment Decisions

On the Applicability of WACC for Investment Decisions On the Applicability of WACC for Investment Decisions Jaime Sabal Department of Financial Management and Control ESADE. Universitat Ramon Llull Received: December, 2004 Abstract Although WACC is appropriate

More information

Investment Decision Analysis

Investment Decision Analysis Lecture: IV 1 Investment Decision Analysis The investment decision process: Generate cash flow forecasts for the projects, Determine the appropriate opportunity cost of capital, Use the cash flows and

More information

On the Rate of Return and Valuation of Non-Conventional Projects

On the Rate of Return and Valuation of Non-Conventional Projects On the Rate of Return and Valuation of Non-Conventional Projects Carlos Heitor Campani Professor of Finance at COPPEAD Graduate School of Business (Federal University of Rio de Janeiro) Research Associate

More information

Project Management Seminars. Financial Management of Projects

Project Management Seminars. Financial Management of Projects Project Management Seminars Financial Management of Projects.inproject managementandsystems engineering, is a deliverable-oriented decomposition of a project into smaller components. (source: Wikipedia)

More information

EXAM 1 REVIEW QUESTIONS

EXAM 1 REVIEW QUESTIONS EXAM 1 REVIEW QUESTIONS 1) Free cash flow. Consider the following financial statements for United Technologies Corp. What is UT's free cash flow (total cash flow from assets) for 2001? UNITED TECHNOLOGIES:

More information

Capital Budgeting. Finance 100

Capital Budgeting. Finance 100 Capital Budgeting Finance 100 Prof. Michael R. Roberts 1 Topic Overview How should capital be allocated?» Do I invest / launch a product / buy a building / scrap / outsource...» Should I acquire / sell

More information

WHAT IS CAPITAL BUDGETING?

WHAT IS CAPITAL BUDGETING? WHAT IS CAPITAL BUDGETING? Capital budgeting is a required managerial tool. One duty of a financial manager is to choose investments with satisfactory cash flows and rates of return. Therefore, a financial

More information

UNIVERSITY OF WAH Department of Management Sciences

UNIVERSITY OF WAH Department of Management Sciences BBA-330: FINANCIAL MANAGEMENT UNIVERSITY OF WAH COURSE DESCRIPTION/OBJECTIVES The module aims at building competence in corporate finance further by extending the coverage in Business Finance module to

More information

1 (a) Calculation of net present value (NPV) Year 1 2 3 4 5 6 $000 $000 $000 $000 $000 $000 Sales revenue 1,600 1,600 1,600 1,600 1,600

1 (a) Calculation of net present value (NPV) Year 1 2 3 4 5 6 $000 $000 $000 $000 $000 $000 Sales revenue 1,600 1,600 1,600 1,600 1,600 Answers Fundamentals Level Skills Module, Paper F9 Financial Management December 2011 Answers 1 (a) Calculation of net present value (NPV) Year 1 2 3 4 5 6 $000 $000 $000 $000 $000 $000 Sales revenue 1,600

More information

CHAPTER 8: ESTIMATING CASH FLOWS

CHAPTER 8: ESTIMATING CASH FLOWS CHAPTER 8: ESTIMATING CASH FLOWS 8-1 a. Straight line depreciation = ($15 - $3)/10 = $1.20 Annual Tax Savings from Depreciation = $ 1.2 (0.4) = $0.48 Present Value of Tax Savings from Depreciation = $

More information

CHAPTER 9 NET PRESENT VALUE AND OTHER INVESTMENT CRITERIA

CHAPTER 9 NET PRESENT VALUE AND OTHER INVESTMENT CRITERIA CHAPTER 9 NET PRESENT VALUE AND OTHER INVESTMENT CRITERIA Answers to Concepts Review and Critical Thinking Questions 1. A payback period less than the project s life means that the NPV is positive for

More information

CHAPTER 9 NET PRESENT VALUE AND OTHER INVESTMENT CRITERIA

CHAPTER 9 NET PRESENT VALUE AND OTHER INVESTMENT CRITERIA CHAPTER 9 NET PRESENT VALUE AND OTHER INVESTMENT CRITERIA 1. To calculate the payback period, we need to find the time that the project has recovered its initial investment. After three years, the project

More information

CHAPTER 7 MAKING CAPITAL INVESTMENT DECISIONS

CHAPTER 7 MAKING CAPITAL INVESTMENT DECISIONS CHAPTER 7 MAKING CAPITAL INVESTMENT DECISIONS Answers to Concepts Review and Critical Thinking Questions 1. In this context, an opportunity cost refers to the value of an asset or other input that will

More information

Capital Investment Appraisal Techniques

Capital Investment Appraisal Techniques Capital Investment Appraisal Techniques To download this article in printable format click here A practising Bookkeeper asked me recently how and by what methods one would appraise a proposed investment

More information

Performance Review for Electricity Now

Performance Review for Electricity Now Performance Review for Electricity Now For the period ending 03/31/2008 Provided By Mark Dashkewytch 780-963-5783 Report prepared for: Electricity Now Industry: 23821 - Electrical Contractors Revenue:

More information

Finance 445 Practice Exam Chapters 1, 2, 5, and part of Chapter 6. Part One. Multiple Choice Questions.

Finance 445 Practice Exam Chapters 1, 2, 5, and part of Chapter 6. Part One. Multiple Choice Questions. Finance 445 Practice Exam Chapters 1, 2, 5, and part of Chapter 6 Part One. Multiple Choice Questions. 1. Similar to the example given in class, assume that a corporation has $500 of cash revenue and $300

More information

Valuation. The Big Picture: Part II - Valuation

Valuation. The Big Picture: Part II - Valuation Valuation The Big Picture: Part II - Valuation A. Valuation: Free Cash Flow and Risk Apr 1 Apr 3 Lecture: Valuation of Free Cash Flows Case: Ameritrade B. Valuation: WACC and APV Apr 8 Apr 10 Apr 15 Lecture:

More information

EMBA in Management & Finance. Corporate Finance. Eric Jondeau

EMBA in Management & Finance. Corporate Finance. Eric Jondeau EMBA in Management & Finance Corporate Finance EMBA in Management & Finance Lecture 5: Capital Budgeting For the Levered Firm Prospectus Recall that there are three questions in corporate finance. The

More information

KEY EQUATIONS APPENDIX CHAPTER 2 CHAPTER 3

KEY EQUATIONS APPENDIX CHAPTER 2 CHAPTER 3 KEY EQUATIONS B CHAPTER 2 1. The balance sheet identity or equation: Assets Liabilities Shareholders equity [2.1] 2. The income statement equation: Revenues Expenses Income [2.2] 3.The cash flow identity:

More information

ITU / BDT- COE workshop. Network Planning. Business Planning. Lecture NP- 3.5. Nairobi, Kenya, 7 11 October 2002

ITU / BDT- COE workshop. Network Planning. Business Planning. Lecture NP- 3.5. Nairobi, Kenya, 7 11 October 2002 ITU / BDT- COE workshop Nairobi, Kenya, 7 11 October 2002 Network Planning Lecture NP- 3.5 Business Planning October 8th ITU/BDT-COE Network Planning/ Business Planning - O.G.S. Lecture NP - 3.5 - slide

More information

12. What is the Internal Rate of Return for the project? a. 18.52 percent d. 21.79 percent b. 16.95 percent e. 15.55 percent c. 20.

12. What is the Internal Rate of Return for the project? a. 18.52 percent d. 21.79 percent b. 16.95 percent e. 15.55 percent c. 20. Business Finance Name Examination Four Spring 2005 version 4 Select the best answer for each of the following questions. Mark your selection on the examination and on your scantron. You may also record

More information

PRODUCTIVITY & GROWTH

PRODUCTIVITY & GROWTH Productivity Financial Tools There are a number of financial tools that can be used to measure the financial performance and potential contribution of improvement projects to the productivity of a business.

More information

Chapter 7 Fundamentals of Capital Budgeting

Chapter 7 Fundamentals of Capital Budgeting Chapter 7 Fundamentals of Capital Budgeting 7-1. Pisa Pizza, a seller of frozen pizza, is considering introducing a healthier version of its pizza that will be low in cholesterol and contain no trans fats.

More information

Chapter 10 Risk and Capital Budgeting

Chapter 10 Risk and Capital Budgeting Chapter 10 Risk and Capital Budgeting MULTIPLE CHOICE 1. Operating leverage describes the relationship between... a. EBIT and sales b. taxes and sales c. debt and equity d. fixed costs and variable costs

More information

CHAPTER 7: NPV AND CAPITAL BUDGETING

CHAPTER 7: NPV AND CAPITAL BUDGETING CHAPTER 7: NPV AND CAPITAL BUDGETING I. Introduction Assigned problems are 3, 7, 34, 36, and 41. Read Appendix A. The key to analyzing a new project is to think incrementally. We calculate the incremental

More information

Solutions to Chapter 8. Net Present Value and Other Investment Criteria

Solutions to Chapter 8. Net Present Value and Other Investment Criteria Solutions to Chapter 8 Net Present Value and Other Investment Criteria. NPV A = $00 + [$80 annuity factor (%, periods)] = $00 $80 $8. 0 0. 0. (.) NPV B = $00 + [$00 annuity factor (%, periods)] = $00 $00

More information

DUKE UNIVERSITY Fuqua School of Business. FINANCE 351 - CORPORATE FINANCE Problem Set #1 Prof. Simon Gervais Fall 2011 Term 2.

DUKE UNIVERSITY Fuqua School of Business. FINANCE 351 - CORPORATE FINANCE Problem Set #1 Prof. Simon Gervais Fall 2011 Term 2. DUKE UNIVERSITY Fuqua School of Business FINANCE 351 - CORPORATE FINANCE Problem Set #1 Prof. Simon Gervais Fall 2011 Term 2 Questions 1. Two years ago, you put $20,000 dollars in a savings account earning

More information

In the business world, the rearview mirror is always clearer than the windshield. - Warren Buffett

In the business world, the rearview mirror is always clearer than the windshield. - Warren Buffett ENGM 401 & 620 X1 Fundamentals of Engineering Finance Fall 2010 Lecture 29: Sensitivity Analysis & Uncertainty In the business world, the rearview mirror is always clearer than the windshield. - Warren

More information

Paper F9. Financial Management. Fundamentals Pilot Paper Skills module. The Association of Chartered Certified Accountants

Paper F9. Financial Management. Fundamentals Pilot Paper Skills module. The Association of Chartered Certified Accountants Fundamentals Pilot Paper Skills module Financial Management Time allowed Reading and planning: Writing: 15 minutes 3 hours ALL FOUR questions are compulsory and MUST be attempted. Do NOT open this paper

More information

CHAPTER 8 CAPITAL BUDGETING DECISIONS

CHAPTER 8 CAPITAL BUDGETING DECISIONS CHAPTER 8 CAPITAL BUDGETING DECISIONS Q1. What is capital budgeting? Why is it significant for a firm? A1 A capital budgeting decision may be defined as the firm s decision to invest its current funds

More information

Content Chapter 3.5. Role of business Planning today. Basic concepts. Telecom business modeling. Typical evaluation results

Content Chapter 3.5. Role of business Planning today. Basic concepts. Telecom business modeling. Typical evaluation results ITU / BDT- COE workshop Bangkok, Thailand, 11 15 November 2002 Network Planning Lecture NP- 3.6 Business Planning November 12th ITU/BDT-COE Network Planning/ Business Planning - O.G.S. Lecture NP - 3.6

More information

How much is your pre-revenue company worth?

How much is your pre-revenue company worth? How much is your pre-revenue company worth? RIC Centre Presentation Summary Andrew Maxwell April 14 2011 Introduction 2 Investors and entrepreneurs often ask me to shed some light on how to value prerevenue

More information

Break-Even and Leverage Analysis

Break-Even and Leverage Analysis CHAPTER 6 Break-Even and Leverage Analysis After studying this chapter, you should be able to: 1. Differentiate between fixed and variable costs. 2. Calculate operating and cash break-even points, and

More information

Chapter 17 Corporate Capital Structure Foundations (Sections 17.1 and 17.2. Skim section 17.3.)

Chapter 17 Corporate Capital Structure Foundations (Sections 17.1 and 17.2. Skim section 17.3.) Chapter 17 Corporate Capital Structure Foundations (Sections 17.1 and 17.2. Skim section 17.3.) The primary focus of the next two chapters will be to examine the debt/equity choice by firms. In particular,

More information

CHAPTER 4: FINANCIAL ANALYSIS OVERVIEW

CHAPTER 4: FINANCIAL ANALYSIS OVERVIEW In the financial analysis examples in this book, you are generally given the all of the data you need to analyze the problem. In a real-life situation, you would need to frame the question, determine the

More information

Overview of Financial Management

Overview of Financial Management Overview of Financial Management Uwadiae Oduware FCA Akintola Williams Deloitte 1-1 Definition Financial Management entails planning for the future for a person or a business enterprise to ensure a positive

More information

Chapter 10 Richard A. Brealey Stewart C. Myers Slides by Matthew Will McGraw Hill/Irwin

Chapter 10 Richard A. Brealey Stewart C. Myers Slides by Matthew Will McGraw Hill/Irwin Principles of Corporate Finance Chapter 10 A Project Is Not a Black Box Seventh Edition Richard A. Brealey Stewart C. Myers Slides by Matthew Will - 2 Topics Covered Sensitivity Analysis Break Even Analysis

More information

CHAPTER 6 NET PRESENT VALUE AND OTHER INVESTMENT CRITERIA

CHAPTER 6 NET PRESENT VALUE AND OTHER INVESTMENT CRITERIA CHAPTER 6 NET PRESENT VALUE AND OTHER INVESTMENT CRITERIA Answers to Concepts Review and Critical Thinking Questions 1. Assuming conventional cash flows, a payback period less than the project s life means

More information

Net Present Value and Other Investment Criteria

Net Present Value and Other Investment Criteria Net Present Value and Other Investment Criteria Topics Covered Net Present Value Other Investment Criteria Mutually Exclusive Projects Capital Rationing Net Present Value Net Present Value - Present value

More information

Chapter 7 Fundamentals of Capital Budgeting

Chapter 7 Fundamentals of Capital Budgeting Chapter 7 Fundamentals of Capital Budgeting Copyright 2011 Pearson Prentice Hall. All rights reserved. Chapter Outline 7.1 Forecasting Earnings 7.2 Determining Free Cash Flow and NPV 7.3 Choosing Among

More information

( ) ( )( ) ( ) 2 ( ) 3. n n = 100 000 1+ 0.10 = 100 000 1.331 = 133100

( ) ( )( ) ( ) 2 ( ) 3. n n = 100 000 1+ 0.10 = 100 000 1.331 = 133100 Mariusz Próchniak Chair of Economics II Warsaw School of Economics CAPITAL BUDGETING Managerial Economics 1 2 1 Future value (FV) r annual interest rate B the amount of money held today Interest is compounded

More information

Real Option Liabilities and New Product Development

Real Option Liabilities and New Product Development Journal of Applied Business and Economics Real Option Liabilities and New Product Development Mark J. Shrader Gonzaga University Many financial academics and practitioners have long realized that the standard

More information

NPV with an Option to Delay and Uncertainty

NPV with an Option to Delay and Uncertainty NPV with an Option to Delay and Uncertainty In all the examples and the theory so far, we have assumed perfect foresight when making investment decisions and analyzing future variables. We have also ignored

More information

Investing in unlisted property schemes?

Investing in unlisted property schemes? Investing in unlisted property schemes? Independent guide for investors about unlisted property schemes This guide is for you, whether you re an experienced investor or just starting out. Key tips from

More information

The Reinvestment Assumption Dallas Brozik, Marshall University

The Reinvestment Assumption Dallas Brozik, Marshall University The Reinvestment Assumption Dallas Brozik, Marshall University Every field of study has its little odd bits, and one of the odd bits in finance is the reinvestment assumption. It is an artifact of the

More information

Real Options. The Big Picture: Part II - Valuation

Real Options. The Big Picture: Part II - Valuation Real Options The Big Picture: Part II - Valuation A. Valuation: Free Cash Flow and Risk April 1 April 3 Lecture: Valuation of Free Cash Flows Case: Ameritrade B. Valuation: WACC and APV April 8 April 10

More information

Cost Benefits analysis

Cost Benefits analysis Cost Benefits analysis One of the key items in any business case is an analysis of the costs of a project that includes some consideration of both the cost and the payback (be it in monetary or other terms).

More information

CAPITAL BUDGETING. Net Present Value and Other Investment Criteria

CAPITAL BUDGETING. Net Present Value and Other Investment Criteria CAPITAL BUDGETING Net Present Value and Other Investment Criteria Net Present Value (NPV) Net present value is the difference between an investment s market value (in today s dollars) and its cost (also

More information

Planning for Capital Investments

Planning for Capital Investments 12-1 Planning for Capital Investments Managerial Accounting Fifth Edition Weygandt Kimmel Kieso 12-2 study objectives 1. Discuss capital budgeting evaluation, and explain inputs used in capital budgeting.

More information

TIP If you do not understand something,

TIP If you do not understand something, Valuing common stocks Application of the DCF approach TIP If you do not understand something, ask me! The plan of the lecture Review what we have accomplished in the last lecture Some terms about stocks

More information

Week- 1: Solutions to HW Problems

Week- 1: Solutions to HW Problems Week- 1: Solutions to HW Problems 10-1 a. Payback A (cash flows in thousands): Annual Period Cash Flows Cumulative 0 ($5,000) ($5,000) 1 5,000 (0,000) 10,000 (10,000) 3 15,000 5,000 4 0,000 5,000 Payback

More information

1.1 Introduction. Chapter 1: Feasibility Studies: An Overview

1.1 Introduction. Chapter 1: Feasibility Studies: An Overview Chapter 1: Introduction 1.1 Introduction Every long term decision the firm makes is a capital budgeting decision whenever it changes the company s cash flows. Consider launching a new product. This involves

More information

Chapter 7: Net Present Value and Capital Budgeting

Chapter 7: Net Present Value and Capital Budgeting Chapter 7: Net Present Value and Capital Budgeting 7.1 a. Yes, the reduction in the sales of the company s other products, referred to as erosion, should be treated as an incremental cash flow. These lost

More information

1) Firm value and stock value We demonstrate that maximizing the value of the rm s equity is equivalent tomaximizing the value

1) Firm value and stock value We demonstrate that maximizing the value of the rm s equity is equivalent tomaximizing the value Financial Leverage and Capital Structure Policy A) Introduction The objective of the capital structure decision, like any corporate objective, should be to maximize the value of the rm s equity. In this

More information

Corporate Finance: Final Exam

Corporate Finance: Final Exam Corporate Finance: Final Exam Answer all questions and show necessary work. Please be brief. This is an open books, open notes exam. 1. DayTop Inns is a publicly traded company, with 10 million shares

More information

Risk Analysis and Quantification

Risk Analysis and Quantification Risk Analysis and Quantification 1 What is Risk Analysis? 2. Risk Analysis Methods 3. The Monte Carlo Method 4. Risk Model 5. What steps must be taken for the development of a Risk Model? 1.What is Risk

More information

Valuation of Your Early Drug Candidate. By Linda Pullan, Ph.D. www.sharevault.com. Toll-free USA 800-380-7652 Worldwide 1-408-717-4955

Valuation of Your Early Drug Candidate. By Linda Pullan, Ph.D. www.sharevault.com. Toll-free USA 800-380-7652 Worldwide 1-408-717-4955 Valuation of Your Early Drug Candidate By Linda Pullan, Ph.D. www.sharevault.com Toll-free USA 800-380-7652 Worldwide 1-408-717-4955 ShareVault is a registered trademark of Pandesa Corporation dba ShareVault

More information

Using simulation to calculate the NPV of a project

Using simulation to calculate the NPV of a project Using simulation to calculate the NPV of a project Marius Holtan Onward Inc. 5/31/2002 Monte Carlo simulation is fast becoming the technology of choice for evaluating and analyzing assets, be it pure financial

More information

: Corporate Finance. Valuation and Capital Structure

: Corporate Finance. Valuation and Capital Structure 380.760: Corporate Finance Lecture 9: Advanced Valuation with Capital Structure Professor Gordon M. Bodnar 2008 Gordon Bodnar, 2008 Valuation and Capital Structure In the real world with market imperfections,

More information

CHAPTER 17 CAPITAL STRUCTURE: LIMITS TO THE USE OF DEBT

CHAPTER 17 CAPITAL STRUCTURE: LIMITS TO THE USE OF DEBT CHAPTER 17 B- 1 CHAPTER 17 CAPITAL STRUCTURE: LIMITS TO THE USE OF DEBT Answers to Concepts Review and Critical Thinking Questions 1. Direct costs are potential legal and administrative costs. These are

More information

Management Accounting 305 Return on Investment

Management Accounting 305 Return on Investment Management Accounting 305 Return on Investment Profit or net income without question is a primary goal of any business. Any business that fails to be profitable in the long run will not survive or will

More information

Chapter. Cost-Volume-Profit Relationships

Chapter. Cost-Volume-Profit Relationships Chapter 6 Cost-Volume-Profit Relationships 6-2 LEARNING OBJECTIVES After studying this chapter, you should be able to: 1. Explain how changes in activity affect contribution margin. 2. Compute the contribution

More information

AN INTRODUCTION TO REAL ESTATE INVESTMENT ANALYSIS: A TOOL KIT REFERENCE FOR PRIVATE INVESTORS

AN INTRODUCTION TO REAL ESTATE INVESTMENT ANALYSIS: A TOOL KIT REFERENCE FOR PRIVATE INVESTORS AN INTRODUCTION TO REAL ESTATE INVESTMENT ANALYSIS: A TOOL KIT REFERENCE FOR PRIVATE INVESTORS Phil Thompson Business Lawyer, Corporate Counsel www.thompsonlaw.ca Rules of thumb and financial analysis

More information

Ch. 18: Taxes + Bankruptcy cost

Ch. 18: Taxes + Bankruptcy cost Ch. 18: Taxes + Bankruptcy cost If MM1 holds, then Financial Management has little (if any) impact on value of the firm: If markets are perfect, transaction cost (TAC) and bankruptcy cost are zero, no

More information

HO-23: METHODS OF INVESTMENT APPRAISAL

HO-23: METHODS OF INVESTMENT APPRAISAL HO-23: METHODS OF INVESTMENT APPRAISAL After completing this exercise you will be able to: Calculate and compare the different returns on an investment using the ROI, NPV, IRR functions. Investments: Discounting,

More information