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13.1 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
Chapter 13
Capital BudgetingTechniques
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13.2 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
After Studying Chapter 13,
you should be able to:
1. Understand the payback period (PBP) method of project evaluation andselection, including its: (a) calculation; (b) acceptance criterion; (c)advantages and disadvantages; and (d) focus on liquidity rather thanprofitability.
2. Understand the three major discounted cash flow (DCF) methods of
project evaluation and selection internal rate of return (IRR), netpresent value (NPV), and profitability index (PI).
3. Explain the calculation, acceptance criterion, and advantages (over thePBP method) for each of the three major DCF methods.
4. Define, construct, and interpret a graph called an NPV profile.
5. Understand why ranking project proposals on the basis of IRR, NPV, and
PI methods may lead to conflicts in rankings.6. Describe the situations where ranking projects may be necessary and
justify when to use either IRR, NPV, or PI rankings.
7. Understand how sensitivity analysis allows us to challenge the single-point input estimates used in traditional capital budgeting analysis.
8. Explain the role and process of project monitoring, including progress
reviews and post-completion audits.
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13.3 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
Cap ital Budgeting
Techniques
Project Evaluation and Selection
Potential Difficulties Capital Rationing
Project Monitoring Post-Completion Audit
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13.4 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
Projec t Evaluat ion :
A lternat ive Methods
Payback Period (PBP)
Internal Rate of Return (IRR) Net Present Value (NPV)
Profitability Index (PI)
Refer to the additional PowerPoint slides and the Excelspreadsheet VW13E-13b.xlsx for computer-basedsolutions.
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13.5 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
Proposed Pro ject Data
Julie Miller is evaluating a new projectfor her firm, Basket Wonders (BW).
She has determined that the after-taxcash flows for the project will be
$10,000; $12,000; $15,000; $10,000;
and $7,000, respectively, for each oftheYears 1 through 5. The initial
cash outlay will be $40,000.
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13.6 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
Independen t Projec t
Independent A project whoseacceptance (or rejection) does notprevent the acceptance of otherprojects under consideration.
For this project, assume that it isindependentof any other potential
projects that Basket Wondersmayundertake.
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7/6513.7 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
Payback Period (PBP)
PBP is the period of timerequired for the cumulative
expected cash flows from aninvestment project to equal the
initial cash outflow.
0 1 2 3 4 5
40 K 10 K 12 K 15 K 10 K 7 K
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8/6513.8 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
(c)10 K 22 K 37 K 47 K 54 K
Payback Solu t ion (#1)
PBP = a + ( bc ) / d= 3 + (4037) / 10
= 3 + (3) / 10= 3.3 Years
0 1 2 3 4 5
40 K 10 K 12 K 15 K 10 K 7 K
Cumulative
Inflows
(a)
(-b) (d)
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13.9 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
Payback Solu t ion (#2)
PBP = 3 + ( 3K ) / 10K
= 3.3 Years
Note: Take absolute value of lastnegative cumulative cash flow value.
Cumulative
Cash Flows
40 K 10 K 12 K 15 K 10 K 7 K
0 1 2 3 4 5
40 K 30 K 18 K 3 K 7 K 14 K
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13.10 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
PBP Acceptance Criter ion
Yes! The firm will receive back theinitial cash outlay in less than 3.5years. [3.3 Years < 3.5 Year Max.]
The management ofBasket Wondershas set a maximum PBP of3.5
years for projects of this type.
Should this project be accepted?
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13.11 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
PBP Streng ths
and Weaknesses
Strengths:
Easy to use andunderstand
Can be used as ameasure ofliquidity
Easier to forecastST than LT flows
Weaknesses:
Does not accountfor TVM
Does not considercash flows beyondthe PBP
Cutoff period issubjective
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13.12 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
In ternal Rate o f Retu rn (IRR)
IRR is the discount rate that equates thepresent value of the future net cash
flows from an investment project withthe projects initial cash outflow.
CF1 CF2 CFn
(1 + IRR)1 (1 + IRR)2 (1 + IRR)n+ . . . ++ICO =
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13.13 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
$15,000 $10,000 $7,000
IRR So lu t ion
$10,000 $12,000
(1+IRR)1
(1+IRR)2
Find the interest rate (IRR) that causes thediscounted cash flows to equal $40,000.
+ +
++$40,000 =
(1+IRR)3 (1+IRR)4 (1+IRR)5
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13.14 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
IRR So lu tion (Try 10%)
$40,000 = $10,000(PVIF10%,1) + $12,000(PVIF10%,2) +$15,000(PVIF10%,3) + $10,000(PVIF10%,4) +
$ 7,000(PVIF10%,5)$40,000 = $10,000(0.909) + $12,000(0.826) +
$15,000(0.751) + $10,000(0.683) +$ 7,000(0.621)
$40,000 = $9,090 + $9,912 + $11,265 +$6,830 + $4,347
= $41,444 [Rate is too low !!]
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13.15 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
IRR So lu tion (Try 15%)
$40,000 = $10,000(PVIF15%,1) + $12,000(PVIF15%,2) +$15,000(PVIF15%,3) + $10,000(PVIF15%,4) +
$ 7,000(PVIF15%,5)$40,000 = $10,000(0.870) + $12,000(0.756) +
$15,000(0.658) + $10,000(0.572) +$ 7,000(0.497)
$40,000 = $8,700 + $9,072 + $9,870 +$5,720 + $3,479
= $36,841 [Rate is too h igh!!]
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13.16 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
0.10 $41,444
0.05 IRR $40,000 $4,603
0.15 $36,841
X $1,4440.05 $4,603
IRR Solu t ion (In terpo late)
$1,444X
=
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13.17 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
0.10 $41,444
0.05 IRR $40,000 $4,603
0.15 $36,841
X $1,4440.05 $4,603
IRR Solu t ion (In terpo late)
$1,444X
=
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13.18 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
0.10 $41,444
0.05 IRR $40,000 $4,603
0.15 $36,841
($1,444)(0.05)$4,603
IRR Solu t ion (In terpo late)
$1,444X
X = X = 0.0157
IRR = 0.10 + 0.0157 = 0.1157 or11.57%
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13.19 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
IRR Accep tance Cri ter ion
No! The firm will receive 11.57% foreach dollar invested in this project ata cost of13%. [ IRR< Hurdle Rate ]
The management ofBasket Wondershas determined that the hurdle rate
is 13% for projects of this type.Should this project be accepted?
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13.20 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
IRRs on the Calcu lato r
We will use thecash flow registry
to solve the IRRfor this problem
quickly and
accurately!
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13.21 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
Actual IRR Solut ion Using
Your Financ ial Calcu lato r
Steps in the ProcessStep 1: Press CF key
Step 2: Press 2nd CLR Work keys
Step 3: ForCF0Press -40000 Enter keysStep 4: ForC01Press 10000 Enter keysStep 5: ForF01Press 1 Enter keysStep 6: ForC02Press 12000 Enter keysStep 7: ForF02Press 1 Enter keysStep 8: ForC03Press 15000 Enter keysStep 9: ForF03Press 1 Enter keys
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13.22 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
Actual IRR Solut ion Using
Your Financ ial Calcu lato r
Steps in the Process (Part II)Step 10:ForC04Press 10000 Enter keysStep 11:ForF04Press 1 Enter keysStep 12:ForC05Press 7000 Enter keysStep 13:ForF05Press 1 Enter keysStep 14: Press keysStep 15: Press IRR key
Step 16: Press CPT key
Result: In ternal Rate o f Return= 11.47%
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13.23 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
IRR Streng ths
and Weaknesses
Strengths:
Accounts forTVM
Considers all
cash flows Less
subjectivity
Weaknesses:
Assumes all cashflows reinvested atthe IRR
Difficulties withproject rankings andMultiple IRRs
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13.24 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
Net Present Value (NPV)
NPVis the present value of aninvestment projects net cash
flows minus the projects initialcash outflow.
CF1 CF2 CFn
(1+k)1 (1+k)2 (1+k)n+ . . . ++ -ICONPV =
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13.25 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
Basket Wondershas determined that theappropriate discount rate (k) for this
project is 13%.
$10,000 $7,000
NPV So lut ion
$10,000 $12,000 $15,000
(1.13)1 (1.13)2 (1.13)3+ +
+ - $40,000(1.13)4 (1.13)5
NPV= +
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13.26 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
NPV So lut ion
NPV = $10,000(PVIF13%,1) + $12,000(PVIF13%,2) +$15,000(PVIF13%,3) + $10,000(PVIF13%,4) +$ 7,000(PVIF13%,5)$40,000
NPV = $10,000(0.885) + $12,000(0.783) +$15,000(0.693) + $10,000(0.613) +$ 7,000(0.543)$40,000
NPV = $8,850 + $9,396 + $10,395 +$6,130 + $3,801$40,000
= - $1,428
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13.27 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
NPV Accep tance Cri ter ion
No! The NPV is negat ive. This meansthat the project is reducing shareholderwealth. [Rejectas NPV< 0]
The management ofBasket Wondershas determined that the required
rate is 13% for projects of this type.
Should this project be accepted?
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13.28 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
NPV on the Calcu lato r
We will use the cashflow registry to solve
the NPV for thisproblem quickly and
accurately!
Hint: If you have no tcleared the cash flowsfrom your calculator, thenyou may skip to Step 15.
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13.29 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
Actual NPV Solut ion Using
Your Financ ial Calcu lato r
Steps in the Process
Step 1: Press CF key
Step 2: Press 2
nd
CLR Work keysStep 3: ForCF0Press -40000 Enter keysStep 4: ForC01Press 10000 Enter keysStep 5: ForF01Press 1 Enter keysStep 6: ForC02Press 12000 Enter keysStep 7: ForF02Press 1 Enter keysStep 8: ForC03Press 15000 Enter keysStep 9: ForF03Press 1 Enter keys
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13.30 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
Steps in the Process (Part II)Step 10:ForC04Press 10000 Enter keysStep 11:ForF04Press 1 Enter keysStep 12:ForC05Press 7000 Enter keysStep 13:ForF05Press 1 Enter keysStep 14: Press keysStep 15: Press NPV key
Step 16: For I=, Enter 13 Enter keysStep 17: Press CPT key
Result: Net Presen t Value= -$1,424.42
Actual NPV Solut ion Using
Your Financ ial Calcu lato r
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13.31 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
NPV Streng ths
and Weaknesses
Strengths:
Cash flowsassumed to bereinvested at thehurdle rate.
Accounts for TVM.
Considers all
cash flows.
Weaknesses:
May not includemanagerialoptions embeddedin the project. See
Chapter 14.
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13.32 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
Net Present Value Pro f i le
Discount Rate (%)
0 3 6 9 12 15
IRRNPV@13%
Sum of CFs Plot NPV for eachdiscount rate.
N
etPresentValue
$000s
15
10
5
0
-4
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13.33 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
Creating NPV Pro fi les
Using the Calcu lator
Hint: As long as youdo not clear the
cash flows from theregistry, simply startat Step 15 and entera different discount
rate. Each resultingNPV will provide apoint for yourNPV
Profi le!
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13.34 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
Pro fi tab i l i ty Index (PI)
PI is the ratio of the present value ofa projects future net cash flows to
the projects initial cash outflow.
CF1 CF2 CFn
(1+k)1 (1+k)2 (1+k)n+ . . . ++ ICOPI =
PI = 1 + [ NPV / ICO]
>
Method #2:
Method #1:
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13.35 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
PI Accep tance Cri ter ion
No! The PI is less than 1.00. Thismeans that the project is not profitable.[Rejectas PI< 1.00]
PI = $38,572 / $40,000
= .9643 (Method #1, previous sl ide)
Should this project be accepted?
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13.36 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
PI Streng ths
and Weaknesses
Strengths:
Same as NPV Allows
comparison of
different scaleprojects
Weaknesses:
Same as NPV Provides only
relative profitability
Potential RankingProblems
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13.37 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
Evaluation Summary
Method Project Comparison DecisionPBP 3.3 3.5 Accept
IRR 11.47% 13% Reject
NPV -$1,424 $0 Reject
PI .96 1.00 Reject
Basket WondersIndependent Project
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13.38 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
Project Evaluat ion : Remember
Chapter 12 New Asset project?
We will start with the cashflows of the project and also
calculate the cumulative
cash flow values.
We can use Excel functions / approaches to calculate each ofthe following methods from the above cash flows.
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13.39 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
Other Pro jec t
Relat ionships
Mutually Exclusive A project whose
acceptance precludes the acceptanceof one or more alternative projects.
Dependent A project whoseacceptance depends on the
acceptance of one or more otherprojects.
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13.40 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
Poten t ial Prob lems
Under Mu tual Exclus iv i ty
A. Scale of Investment
B. Cash-flow Pattern
C. Project Life
Ranking of project proposals maycreate contradictory results.
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13.41 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
A. Scale Differences
Compare a small (S) and alarge (L) project.
NET CASH FLOWS
Project S Project LEND OF YEAR
0 -$100 -$100,0001 0 0
2 $400 $156,250
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13.42 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
A. Scale Differences
Calculate the PBP, IRR, NPV@10%,and PI@10%.
Which project is preferred? Why?
Project IRR NPV PI
S 100% $ 231 3.31
L 25% $29,132 1.29
Remember to refer to Excel spreadsheet
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13.43 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
A. Scale Differences
Refer to VW13E-13b.xlsx on the Scale tab.
Remember to refer to Excel spreadsheetVW13E-13b.xlsx and the Scale tab.
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13.44 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
B. Cash Flow Pattern
Let us compare a decreasingcash-flow (D)project and an increasingcash-flow (I) project.
NET CASH FLOWSProject D Project IEND OF YEAR
0 -$1,200 -$1,200
1 1,000 1002 500 600
3 100 1,080
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13.45 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
D 23% $198 1.17
I 17% $198 1.17
Cash Flow Pattern
Calculate the IRR, NPV@10%,and PI@10%.
Which project is preferred?
Project IRR NPV PI
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13.46 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
Exam ine NPV Pro fi les
Discount Rate (%)
0 5 10 15 20 25-200
0
200
400
600
IRR
NPV@10%
Plot NPV for eachproject at various
discount rates.
NetPresentValue($)
Project I
Project D
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13.47 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
Fishers Rate of Intersection
Discount Rate ($)
0 5 10 15 20 25-200
0
200
400
600
Net
PresentValue($)
At k10%, D is best!
Remember to refer to Excel spreadsheet
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13.48 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
B. Cash Flow Pattern
Refer to VW13E-13b.xlsx on the Pattern tab.
Remember to refer to Excel spreadsheetVW13E-13b.xlsx and the Pattern tab.
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13.49 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
C. Pro jec t L ife Differences
Let us compare a l onglife (X) projectand a shor tlife (Y) project.
NET CASH FLOWSProject X Project YEND OF YEAR
0 -$1,000 -$1,000
1 0 2,0002 0 0
3 3,375 0
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13.50 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
X 50% $1,536 2.54
Y 100% $ 818 1.82
Pro jec t L ife Differences
Calculate the PBP, IRR, NPV@10%,and PI@10%.
Which project is preferred? Why?
Project IRR NPV PI
Remember to refer to Excel spreadsheet
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13.51 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
C. Pro jec t L ife Differences
Remember to refer to Excel spreadsheetVW13E-13b.xlsx and the Life tab.
A th W t
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13.52 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
Ano ther Way to
Look at Things
1. Adjust cash flows to a common terminalyear if project Y will NOTbe replaced.
Compound Project Y, Year 1 @10% for 2 years.
Year 0 1 2 3
CF $1,000 $0 $0 $2,420
Results: IRR* = 34.26% NPV = $818
*Lower IRRfrom adjusted cash-flow stream. X is still Best.
R l i P j t
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13.53 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
Rep lac ing Pro jec ts
w ith Iden t ical Projects
2. Use Replacement Chain Approach(Appendix B)when project Y will be replaced.
0 1 2 3
$1,000 $2,000
1,000 $2,0001,000 $2,000
$1,000 $1,000 $1,000 $2,000
Results: IRR = 100% NPV* = $2,238.17
*Higher NPV, but the same IRR. Y is Best.
Remember to refer to Excel spreadsheet
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13.54 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
C. Pro jec t L ife Differences
pVW13E-13b.xlsx and the Life2 tab.
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13.55 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
Cap ital Ration ing
Cap ital Ration ingoccurs when aconstraint (or budget ceiling) is placed
on the total size of capital expendituresduring a particular period.
Example: Julie Miller must determine what
investment opportunities to undertake forBasket Wonders (BW). She is limited to amaximum expenditure of $32,500 onlyforthis capital budgeting period.
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13.56 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
Avai lab le Pro jects fo r BW
Project ICO IRR NPV PI
A $ 500 18% $ 50 1.10
B 5,000 25 6,500 2.30C 5,000 37 5,500 2.10D 7,500 20 5,000 1.67E 12,500 26 500 1.04
F 15,000 28 21,000 2.40G 17,500 19 7,500 1.43H 25,000 15 6,000 1.24
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13.57 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
Choos ing by IRRs for BW
Project ICO IRR NPV PI
C $ 5,000 37% $ 5,500 2.10
F 15,000 28 21,000 2.40E 12,500 26 500 1.04B 5,000 25 6,500 2.30
Projects C, F, and E have the
three larges t IRRs.
The resulting increasein shareholder wealthis $27,000 with a $32,500 outlay.
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13.58 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
Choos ing by NPVs for BW
Project ICO IRR NPV PI
F $15,000 28% $21,000 2.40
G 17,500 19 7,500 1.43B 5,000 25 6,500 2.30
Projects F and G have the
two largest NPVs.The resulting increasein shareholder wealth
is $28,500 with a $32,500 outlay.
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13.59 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
Choos ing by PIs for BW
Project ICO IRR NPV PI
F $15,000 28% $21,000 2.40
B 5,000 25 6,500 2.30C 5,000 37 5,500 2.10D 7,500 20 5,000 1.67G 17,500 19 7,500 1.43
Projects F, B, C, and D have the fourlarges t PIs.
The resulting increasein shareholder wealth is$38,000 with a $32,500 outlay.
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13.60 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
Summary of Compar ison
Method Projects Accepted Value Added
PI F, B, C, and D $38,000
NPV F and G $28,500
IRR C, F, and E $27,000
PI generates the greatestincreaseinshareho lder wealthwhen a limited capital
budget exists for a sing le per iod.
Si l P i t E t i t
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13.61 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
Sing le-Poin t Estimate
and Sens i t iv i ty Analys is
Allows us to change from single-point (i.e.,revenue, installation cost, salvage, etc.) estimatesto a what if analysis
Utilize a base-case to compare the impact ofindividual variable changes
E.g., Change forecasted sales units to seeimpact on the projects NPV
Sens i t iv i ty Analysis: A type of what-ifuncertainty analysis in which variables orassumptions are changed from a base case in
order to determine their impact on a projectsmeasured results (such as NPV or IRR).
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13.62 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
Post-Complet ion Audi t
Post-complet ion Aud i t
A formal comparison of the actual costs and
benefits of a project with original estimates.
Identify any project weaknesses
Develop a possible set of corrective actions Provide appropriate feedback
Result: Making better future decisions!
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13.63 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
Mult iple IRR Prob lem *
Two!! There are as many potentialIRRs as there are sign changes.
Let us assume the following cash flowpattern for a project for Years 0 to 4:
$100 +$100 +$900 $1,000
How many potent ia lIRRs could thisproject have?
* Refer to Appendix A
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13.64 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
NPV Pro fi le Mult ip le IRRs
Discount Rate (%)
0 40 80 120 160 200
NetPresentValue
($000s
)
Multiple IRRs atk = 12.95% and 191.15%
75
50
25
0
100
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NPV Pro fi le Mult ip le IRRs
Hint: Your calculatorwill only find ONE
IRR even if thereare multiple IRRs. It
will give you thelowest IRR. In this
case, 12.95%.