Post on 24-Feb-2018
7/25/2019 Time Valuations 7
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Time Valuations
7/25/2019 Time Valuations 7
2/25
2012 BSE Institute LimitedCorporate Finance -1/Capital Budgeting
Session VII - X
At the end of this session, you will be able to:
Review the concept of time value of money
nde!stand the need fo! !is" f!ee !ate in cash #ow valuations
nde!stand va!ious time value concepts such as $et %!esent Value
Inte!nal Rate of Retu!n
&odi'ed Inte!nal Rate of Retu!n
(iscounted )ash *low ðod
%ay +ac" %e!iod %e!petuity and Annuity
2
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2012 BSE Institute LimitedCorporate Finance -1/Capital Budgeting
Valuations %lannin.
*inancial fo!ecastin. involves p!edictin. futu!e #ow of cash in and out ofthe company
)apital bud.et can be dissected into two pa!ts /
a0 )apital / !efe!s to ope!atin. assets in p!oduction
b0 +ud.et / is a plan that details p!o1ected cash #ows du!in. some futu!epe!iod
The!efo!e,
)apital bud.etin. is the whole p!ocess of analy2in. the p!o1ects anddecidin. which one to include in the capital bud.et
It is a p!ocess of evaluatin. speci'c investment decisions
7/25/2019 Time Valuations 7
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2012 BSE Institute LimitedCorporate Finance -1/Capital Budgeting
)apital +ud.etin.
$eed fo! capital bud.etin. /
A '!m3s capital bud.etin. decisions must de'ne its st!ate.ic di!ection%lannin. is essential because launchin. of a new p!oducts, se!vices o!ma!"ets is p!eceded by capital e4penditu!e
Results of capital bud.etin. decisions may be achieved in many yea!sto come
%oo! investments can lead to non-optimal utilisation of 'nancial!esou!ces
7/25/2019 Time Valuations 7
5/25
2012 BSE Institute LimitedCorporate Finance -1/Capital Budgeting
)apital +ud.etin.
)apital 54penditu!e / Types, classi'cations and decisions
Replacement: &aintenance of business 6Should we ca!!y on 70
Replacement: )ost !eduction 6)ut cost th!ou.h alte!natives0
54pansion into e4istin. and new ma!"ets 68ow can we 70
54penditu!e on p!oduct 9uality and 9uantity enhancement
Safety ando! 5nvi!onment %!o1ects 6Social !esponsibility0
Resea!ch and (evelopment 6%!oduct enhancement0
;on. te!m cont!acts 6Secu!in. ma!"et deals0
7/25/2019 Time Valuations 7
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2012 BSE Institute LimitedCorporate Finance -1/Capital Budgeting
Recall: Time Value of &oney
TVMis the value of money '.u!in. in a .iven amount of inte!est ea!nedove! a .iven amount of time
The time value of money is the cent!al concept in fnance theory.
The method allows the valuation of a li"ely st!eam of income in the futu!e,in such a way that the annual incomes a!e discounted and then addedto.ethe!, thus p!ovidin. a lump-sum
7/25/2019 Time Valuations 7
7/25
2012 BSE Institute LimitedCorporate Finance -1/Capital Budgeting
sa.e of Time Value of &oney
Techni9ues fo! )apital +ud.etin. /
a0 %aybac" %e!iod
b0 (iscounted %aybac" %e!iod
c0 $et %!esent Value
d0 Inte!nal Rate of Retu!n
e0 &odi'ed Inte!nal Rate of Retu!n
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2012 BSE Institute LimitedCorporate Finance -1/Capital Budgeting
(iscount Rate, 8ow to )hoose
In#ation Rate
T!easu!y +ill =ield
Annuali2ed Stoc" &a!"et Retu!ns
>-Sec +ond =ield
+an" Rate
*i4ed (eposit
7/25/2019 Time Valuations 7
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2012 BSE Institute LimitedCorporate Finance -1/Capital Budgeting
$et %!esent Value
$et %!esent Value / In p!inciple, simila! to the discounted cash #ow method
%!o1ects with positive $%V should be accepted If not, the p!o1ect must be!e1ected If two p!o1ects have positive $%V, then the one with hi.he! $%Vmust be accepted
;in": $%V
http://net%20present%20value.xls/http://net%20present%20value.xls/7/25/2019 Time Valuations 7
10/25
2012 BSE Institute LimitedCorporate Finance -1/Capital Budgeting
%ay +ac" ðod
54pected Afte! / Ta4
$et )ash *low, )*t
=ea! 6t0 %!o1ect S %!o1ect T
? 6I$R @???0 6I$R @???0
@ ?? @??
B C?? D??
D D?? C??
C @?? E??
%!o1ect S has hi.he! cash #ows at the be.innin. of ope!ation
*o! %!o1ect T, hi.he! cash #ows comes as yea!s pass on
Fhich of these two options a!e optimal f!om investment and !evenuepoint of you 7
7/25/2019 Time Valuations 7
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2012 BSE Institute LimitedCorporate Finance -1/Capital Budgeting
%ay +ac" ðod
%aybac" %e!iod / is the numbe! of yea!s !e9ui!ed to !ecove! the o!i.inal investment
Initial Investment / I$R @???
Net Cash Flow -1000 500 400 300 100Cumulative NCF -1000 -500 -100 200 300
Project S
Net Cash Flow -1000 100 300 400 600
Cumulative NCF -1000 -900 -600 -200 400
Project T
7/25/2019 Time Valuations 7
12/25
2012 BSE Institute LimitedCorporate Finance -1/Capital Budgeting
%ay +ac" ðod
Techniques or Capital Budgeting
Payback.Discounted Payback.et Present Value.!nternal "ate o "eturn.Modifed !nternal "ate o "eturn.Proftability !nde#.
!recovere" Cost at the
Start o# $ear
Cash #low %uri!& the
$ear
$ear 'e#ore Full (ecover) *Pa) 'ac+ ,erio"
Pa)'ac+ Short Term 2 * .100/300
233 )ears
Pa)'ac+ o!& Term 3 * .200/600
333 )ears
7/25/2019 Time Valuations 7
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2012 BSE Institute LimitedCorporate Finance -1/Capital Budgeting
(iscounted )ash *low
(iscounted %aybac" %e!iod /
8ow !ealistic is the %aybac" %e!iod method 7
(oes it account fo! in#ation facto! time vale of money 7
(%% method allows fo! discountin. of cash #ows The discount !ate used isthe p!o1ect3s cost of capital
The!efo!e, the discounted paybac" pe!iod is de'ned as the numbe! of yea!s
!e9ui!ed to !ecove! the investment f!om the discounted cash #ows
7/25/2019 Time Valuations 7
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2012 BSE Institute LimitedCorporate Finance -1/Capital Budgeting
(iscounted )ash *low
t )ash *low -@??? ?? C?? D??
)umulative $)* @?G -@??? C DD@BB EH
0 1 2 3 4
Project S
(iscounted $)* -@??? C -B@C @@
(iscounted %aybac" %e!iod K B L 6B@CBB0
K BJ yea!s
7/25/2019 Time Valuations 7
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2012 BSE Institute LimitedCorporate Finance -1/Capital Budgeting
(iscounted )ash *low
t )ash *low -@??? @?? D?? C??
)umulative $)* @?G -@??? J@ BCHD?@ C@?
0 1 2 3 4
%!o1ect T
(iscounted $)* -@??? -J?J -EE@ -DE?
(iscounted %aybac" %e!iod K D L 6DE?C@?0
K DH yea!s
7/25/2019 Time Valuations 7
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2012 BSE Institute LimitedCorporate Finance -1/Capital Budgeting
Inte!nal Rate of Retu!n
Inte!nal Rate of Retu!n / is the discount !ate that e9uates the p!esent valueof the p!o1ects cash in#ows to the p!esent value of the p!o1ects costs
Si.ni'cance of IRR /
The IRR on a p!o1ect is its e4pected !ate of !etu!n
If the IRR e4ceeds the cost of the funds used to 'nance the p!o1ect, asu!plus will !emain afte! payin. fo! the capital
A su!plus indicates that the!e is an inc!ease in sha!eholde! wealth
7/25/2019 Time Valuations 7
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2012 BSE Institute LimitedCorporate Finance -1/Capital Budgeting
&odi'ed Inte!nal Rate of Retu!n
&odi'ed Inte!nal Rate of Retu!n /
In &IRR, the cash #ows f!om each p!o1ects a!e !einvested at the cost ofcapital
&IRR is the !ate at which all the futu!e cash #ows a!e !einvested
;in": &IRR
CIFt( 1 + r )n - t
t = 0
n
( 1 + MIRR )
n
=COFt
( 1 + r )t
t = 0
n
. 1 * r t
CFt. 1 * r ! - t
t 0
!
. 1 * (( !
CFtt 0
!
M K
http://mirr.xls/http://mirr.xls/7/25/2019 Time Valuations 7
18/25
2012 BSE Institute LimitedCorporate Finance -1/Capital Budgeting
$et %!esent Value, In detail
)alculatin. $%V based on /
%e!petuities
neven )ash *low %e!petuity
Annuities
a0 N!dina!y Annuities
b0 Annuities (ue
7/25/2019 Time Valuations 7
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2012 BSE Institute LimitedCorporate Finance -1/Capital Budgeting
%e!petuities and Annuities
%e!petuities is the constant st!eam of cash #ows without end
In cont!ast to 'nite numbe! of cash #ows called annuities, pe!petuitiesp!ovide fo! an in'nite unendin. st!eam of cash #ows ove! an un-measu!able pe!iod of time
)an this happen 7
)onsol +onds issued in the O entitles the owne! to !eceive yea!ly inte!estf!om the +!itish .ove!nment Pfo!eve!Q
7/25/2019 Time Valuations 7
20/25
2012 BSE Institute LimitedCorporate Finance -1/Capital Budgeting
%e!petuities and Annuities
Tal"in. of annuities, the te!m constant payment is always !efe!!ed to Inothe! wo!ds, annuities involve payments that a!e the same in eve!ype!iod
A!e the!e any scope of uneven cash #ow 7
If yes, could you thin" of any asset that will .ene!ate, hypothetically, ava!iable cash #ow 77
)ommon Stoc"s and its uneven cash #ow / dividends
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2012 BSE Institute LimitedCorporate Finance -1/Capital Budgeting
>!owin. %e!petuities
>!owin. %e!petuities / Simila! to pe!petuities in te!ms of its application , in.!owin. pe!petuities, the cash #ows a!e e4pected to .!ow at someconstant !ate P.Q
) / cash #ow !eceived one pe!iod
! / discount !ate
. / !ate of .!owth pe! pe!iod
%V K ) L ) 6@ L .0 L )6@ L .0B L )6@ L .0$ / @
6@ L !0 6@ L !0B 6@ L !0D 6@ L !0$
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2012 BSE Institute LimitedCorporate Finance -1/Capital Budgeting
Annuities and *VA3s
An annuity is a level st!eam of !e.ula! payments that lasts fo! a P'4edQnumbe! of pe!iods
54amples:
@0 %ensions
B0 nspeci'ed time based leases
In othe! wo!ds, an annuity is a se!ies of e9ual payments made at '4edinte!vals fo! a speci'ed numbe! of pe!iod
Receipts Received %ayments made at the end of one accountin. pe!iod /
N!dina!y o! (efe!!ed Annuity
Receipts Received %ayments made typically on the @st day of theaccountin. pe!iod / Annuity (ue
7/25/2019 Time Valuations 7
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2012 BSE Institute LimitedCorporate Finance -1/Capital Budgeting
Annuities: %ension
Amount: I$R ?,???
Inte!est Rate: HG
Time: @? y!s
%!esent Value of Annuities: I$R CJ?J?C
;in": %e!petuities and Annuities
http://perpetuity%20and%20annuity%20notes.xls/http://perpetuity%20and%20annuity%20notes.xls/7/25/2019 Time Valuations 7
24/25
2012 BSE Institute LimitedCorporate Finance -1/Capital Budgeting
>!owin. Annuities: %ension
Amount: I$R ?,???
Inte!est Rate: HG
Time: @? y!s
%!esent Value of >!owin. Annuities: I$R CJ?J?C
;in": %e!petuities and Annuities
6@ L i0
http://perpetuity%20and%20annuity%20notes.xls/http://perpetuity%20and%20annuity%20notes.xls/7/25/2019 Time Valuations 7
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2012 BSE Institute LimitedCorporate Finance -1/Capital Budgeting
Than" =ou