Managing Finance and Budgets
description
Transcript of Managing Finance and Budgets
![Page 1: Managing Finance and Budgets](https://reader035.fdocuments.in/reader035/viewer/2022062500/56815319550346895dc13c0a/html5/thumbnails/1.jpg)
Managing Finance and Budgets
Seminar 7
![Page 2: Managing Finance and Budgets](https://reader035.fdocuments.in/reader035/viewer/2022062500/56815319550346895dc13c0a/html5/thumbnails/2.jpg)
Follow-up Activities
Read Chapter 14 (including EPNV) Describe key concepts:
Purpose of Investment Appraisal
Accounting Rate of Return
Payback Period
Discounted Cash Flow
Internal Rate of Return
Cost-benefit analysis Exercises 14.1 and 14.2
![Page 3: Managing Finance and Budgets](https://reader035.fdocuments.in/reader035/viewer/2022062500/56815319550346895dc13c0a/html5/thumbnails/3.jpg)
Questions 1
What precisely is meant by ‘Investment’? Give the full names of the following tools for analysing the
value of an investment, ARR PP NPV IRR
![Page 4: Managing Finance and Budgets](https://reader035.fdocuments.in/reader035/viewer/2022062500/56815319550346895dc13c0a/html5/thumbnails/4.jpg)
Methods of investment appraisal
Four methods of evaluation:
Accounting rate of return (ARR)
Payback period (PP)
Net present value (NPV)
Internal rate of return (IRR)
![Page 5: Managing Finance and Budgets](https://reader035.fdocuments.in/reader035/viewer/2022062500/56815319550346895dc13c0a/html5/thumbnails/5.jpg)
Questions 2
Explain the difference between ARR and PP, Explain why ARR is thought to be the more useful
measure.
![Page 6: Managing Finance and Budgets](https://reader035.fdocuments.in/reader035/viewer/2022062500/56815319550346895dc13c0a/html5/thumbnails/6.jpg)
Average annual profit________ x 100% Average investment to earn that profit
ARR =
Accounting rate of return (ARR)
![Page 7: Managing Finance and Budgets](https://reader035.fdocuments.in/reader035/viewer/2022062500/56815319550346895dc13c0a/html5/thumbnails/7.jpg)
Payback period (PP)
Payback period (PP)
The payback period is the length of time it takes for the initial investment to be repaid
out of the net cash inflows from the project.
![Page 8: Managing Finance and Budgets](https://reader035.fdocuments.in/reader035/viewer/2022062500/56815319550346895dc13c0a/html5/thumbnails/8.jpg)
The cumulative cash flows of project with different types of yield
Project 1
Project 3
Project 2Yr 1
Cash flows (£000)
200 800600400 9000 500300100 700
Yr 2
Yr 3
Yr 5
Yr 4
Yr 1
Yr 2
Yr 3
Yr 5
Yr 4
Yr 1
Yr 2
Yr 3
Yr 4
Yr 5
Yr 1
Payback period
![Page 9: Managing Finance and Budgets](https://reader035.fdocuments.in/reader035/viewer/2022062500/56815319550346895dc13c0a/html5/thumbnails/9.jpg)
Questions 3
Explain why the value of £1000 invested and returned in five year’s time may not be equal to its present value.
State three factors which need to be taken into account in calculating the discount rate used to determine the Net Present Value.
Carry out the calculations to work out the net present value of £1 in 1 year, 2 years, 3 years, 4 years and 5 years time.
M & A Exercise 14.1
![Page 10: Managing Finance and Budgets](https://reader035.fdocuments.in/reader035/viewer/2022062500/56815319550346895dc13c0a/html5/thumbnails/10.jpg)
Interest foregone
InflationDiscount rate
Risk premium
The factors influencing the discount rate to be applied to a project
![Page 11: Managing Finance and Budgets](https://reader035.fdocuments.in/reader035/viewer/2022062500/56815319550346895dc13c0a/html5/thumbnails/11.jpg)
Present value of £1 receivable at various times in the future, assuming an annual financing cost of 20 per cent
(1 + 0.2)0
(1 + 0.2)5
(1 + 0.2)4
(1 + 0.2)1
(1 + 0.2)2
(1 + 0.2)3
1.000
0.833
0.694
0.579
0.482
0.402
Year
1 2 3 4 5
Present value of £1
![Page 12: Managing Finance and Budgets](https://reader035.fdocuments.in/reader035/viewer/2022062500/56815319550346895dc13c0a/html5/thumbnails/12.jpg)
Questions 4
Why is NPV superior to ARR and PP? What factors affect the sensitivity of NPV calculations?
![Page 13: Managing Finance and Budgets](https://reader035.fdocuments.in/reader035/viewer/2022062500/56815319550346895dc13c0a/html5/thumbnails/13.jpg)
Why NPV is superior to ARR and PP
It addresses the following issues:
The timing of the cash flows
The whole of the relevant cash flows
The objectives of the business
![Page 14: Managing Finance and Budgets](https://reader035.fdocuments.in/reader035/viewer/2022062500/56815319550346895dc13c0a/html5/thumbnails/14.jpg)
Factors affecting the sensitivity of NPV calculations
Operating costs
Project NPV
Financing cost
Initial outlay
Sales price Annual sales volume
Project life
![Page 15: Managing Finance and Budgets](https://reader035.fdocuments.in/reader035/viewer/2022062500/56815319550346895dc13c0a/html5/thumbnails/15.jpg)
Questions 5
Explain what is meant by IRR. Explain the relationship between IRR and NPV. M & A 14.2
![Page 16: Managing Finance and Budgets](https://reader035.fdocuments.in/reader035/viewer/2022062500/56815319550346895dc13c0a/html5/thumbnails/16.jpg)
Internal rate of return (IRR)
Internal rate of return (IRR)
The internal rate of return is the discount rate, which, when
applied to the future cash flows of a project, will produce an NPV
of precisely zero.
![Page 17: Managing Finance and Budgets](https://reader035.fdocuments.in/reader035/viewer/2022062500/56815319550346895dc13c0a/html5/thumbnails/17.jpg)
The relationship between the NPV and IRR methods
NPV (£000)
Rate of return (%)
10
20
30
40
50
60
70
0 10 20 30 40
IRR
![Page 18: Managing Finance and Budgets](https://reader035.fdocuments.in/reader035/viewer/2022062500/56815319550346895dc13c0a/html5/thumbnails/18.jpg)
Finding the IRR of an investment by plotting the NPV against the discount rate
NPV(£000)
Discount rate (%)
£18,660 (positive)
+
-
0 G H
NPV £23,490 (negative)
6% 15%
FE
D
![Page 19: Managing Finance and Budgets](https://reader035.fdocuments.in/reader035/viewer/2022062500/56815319550346895dc13c0a/html5/thumbnails/19.jpg)
Questions 5
In addition to the IRR, PP, NPV and IRR analysis what other issues might affect a company’s decision to invest ?
What is the relationship between risk and expected return?
![Page 20: Managing Finance and Budgets](https://reader035.fdocuments.in/reader035/viewer/2022062500/56815319550346895dc13c0a/html5/thumbnails/20.jpg)
Dealing with questions relating to investment appraisal
Some practical points
Relevant costs
Opportunity costs
Taxation
Cash flows and profit flows
![Page 21: Managing Finance and Budgets](https://reader035.fdocuments.in/reader035/viewer/2022062500/56815319550346895dc13c0a/html5/thumbnails/21.jpg)
Relationship between risk and return
Return(%)
Risk
Risk premium
Risk-free rate
![Page 22: Managing Finance and Budgets](https://reader035.fdocuments.in/reader035/viewer/2022062500/56815319550346895dc13c0a/html5/thumbnails/22.jpg)
Questions 6
Describe the stages that you would expect to go through in managing an investment project.
![Page 23: Managing Finance and Budgets](https://reader035.fdocuments.in/reader035/viewer/2022062500/56815319550346895dc13c0a/html5/thumbnails/23.jpg)
Managing the investment decision
Stage 1
Stage 2
Stage 3
Stage 4
Stage 5
Determine investment funds available
Identify profitable project opportunities
Evaluate the proposed project
Approve the project
Monitor and control the project