Upload
angga-bayu
View
221
Download
0
Embed Size (px)
Citation preview
7/31/2019 Ch 12 Capital Budgeting
1/41
12 - 1
Should we
build thisplant?
CHAPTER 12The Basics of Capital Budgeting
7/31/2019 Ch 12 Capital Budgeting
2/41
12 - 2
What is capital budgeting?
Analysis of potential additions tofixed assets.
Long-term decisions; involve largeexpenditures.
Very importantto firms future.
7/31/2019 Ch 12 Capital Budgeting
3/41
12 - 3
Capital Budgeting Decision Rules
5 keys methods to rank project
Payback
Discounted Payback
Accounting Rate of Return
Net Present Value (NPV)
Internal Rate of Return (IRR)
Modified Internal Rate of Return (MIRR)
7/31/2019 Ch 12 Capital Budgeting
4/41
12 - 4
Steps
1. Estimate CFs (inflows & outflows).
2. Assess riskiness of CFs.3. Determine k = WACC (adj.).
4. Find NPV and/or IRR.
5. Accept if NPV > 0 and/or IRR >WACC.
7/31/2019 Ch 12 Capital Budgeting
5/41
12 - 5
What is the difference between
independent and mutually exclusiveprojects?
Projects are:
independent, if the cash flows ofone are unaffected by theacceptance of the other.
mutually exclusive, if the cash flowsof one can be adversely impactedby the acceptance of the other.
7/31/2019 Ch 12 Capital Budgeting
6/41
12 - 6
An Example of Mutually Exclusive
Projects
BRIDGE vs. BOAT to getproducts across a river.
7/31/2019 Ch 12 Capital Budgeting
7/41
12 - 7
Normal Cash Flow Project:
Cost (negative CF) followed by aseries of positive cash inflows.One change of signs.
Nonnormal Cash Flow Project:
Two or more changes of signs.Most common: Cost (negativeCF), then string of positive CFs,then cost to close project.Nuclear power plant, strip mine.
7/31/2019 Ch 12 Capital Budgeting
8/41
12 - 8
Inflow (+) or Outflow (-) in Year
0 1 2 3 4 5 N NN
- + + + + + N- + + + + - NN
- - - + + + N
+ + + - - - N
- + + - + - NN
7/31/2019 Ch 12 Capital Budgeting
9/41
12 - 9
What is the payback period?
- The number of years required to
recover a projects cost,- or how long does it take to get our
money back?
Payback = Year before full recovery +the last unrecovered costCash flow during year
7/31/2019 Ch 12 Capital Budgeting
10/41
12 - 10
Example: Allied Components CompanyProjects net cash flows ($000), Allied
Projects WACC = 10%
Year Project L Project S
0 (100) (100)
1 10 70
2 60 50
3 80 20
7/31/2019 Ch 12 Capital Budgeting
11/41
12 - 11
Payback for Project L
(Long: Large CFs in later years)
10 60
0 1 2 3
-100
=
CFtCumulative -100 -90 -30 50
PaybackL 2 + 30/80 = 2.375 years
0
100
2.4
80
7/31/2019 Ch 12 Capital Budgeting
12/41
12 - 12
Project S (Short: CFs come quickly)
70 2050
0 1 2 3
-100CFt
Cumulative -100 -30 20 40
Paybacks 1 + 30/50 = 1.6 years
100
0
1.6
=
7/31/2019 Ch 12 Capital Budgeting
13/41
12 - 13
Strengths of Payback:
1. Provides an indication of aprojects risk and liquidity.
2. Easy to calculate and understand.
Weaknesses of Payback:
1. Ignores the TVM.2. Ignores CFs occurring after the
payback period.
7/31/2019 Ch 12 Capital Budgeting
14/41
12 - 14
Discounted Payback: Uses discounted
for project L rather than raw CFs.
10 8060
0 1 2 3
CFt
Cumulative -100 -90.91 -41.32 18.79
Discountedpayback 2 + 41.32/60.11 = 2.7 years
PVCFt -100
-100
10%
9.09 49.59 60.11
=
Recover invest. + cap. costs in 2.7 years.
7/31/2019 Ch 12 Capital Budgeting
15/41
12 - 15
Accounting Rate of Return (ARR)
ARR = Average Annual Income
Average Annual Income =
Average Cash Flow Average depreciation
Average Investment =(Cost + Salvage Value)/2
Average Investment
7/31/2019 Ch 12 Capital Budgeting
16/41
12 - 16
Accounting Rate of Return (ARR)
Average Annual Income (AAI) L:
Average cash flow L: 150/3 = 50
Average depreciation: 100/3 = 33.3
AAI L: 50 33.3 = 16.7
Average Investment L:
(Cost + Salvage Value)/2: (100+0)/2 = 50ARR L = 16.7/50 33.4%
ARR S = 13.4/50 26.8%
7/31/2019 Ch 12 Capital Budgeting
17/41
12 - 17
.k1
CFNPV
t
t
n
0t
NPV: Sum of the PVs of inflows andoutflows.
7/31/2019 Ch 12 Capital Budgeting
18/41
12 - 18
Whats Project Ls NPV?
10 8060
0 1 2 310%
Project L:
-100.00
9.09
49.59
60.11
18.79 = NPVL
7/31/2019 Ch 12 Capital Budgeting
19/41
12 - 19
Calculator Solution
Enter in CF for L:
-100
10
60
80
10
CF0
CF1
RCL NPV
CF2
CF3
i% = 18.78 = NPVL
NPVS
= $19.98.
7/31/2019 Ch 12 Capital Budgeting
20/41
12 - 20
Rationale for the NPV Method
NPV = PV inflows Cost= Net gain in wealth.
Accept project if NPV > 0.
Choose between mutuallyexclusive projects on basis ofhigher NPV. Adds most value.
7/31/2019 Ch 12 Capital Budgeting
21/41
12 - 21
Using NPV method, which project(s)
should be accepted?
If Projects S and L are mutuallyexclusive, accept S becauseNPVs > NPVL .
If S & L are independent,accept both; NPV > 0.
7/31/2019 Ch 12 Capital Budgeting
22/41
12 - 22
Internal Rate of Return: IRR
0 1 2 3
CF0 CF1 CF2 CF3Cost Inflows
IRR is the discount rate that forcesPV inflows = cost. This is the sameas forcing NPV = 0.
7/31/2019 Ch 12 Capital Budgeting
23/41
12 - 23
.NPVk1
CFt
t
n
0t
.0IRR1
CFt
tn
0t
NPV: Enter k, solve for NPV.
IRR: Enter NPV = 0, solve for IRR.
7/31/2019 Ch 12 Capital Budgeting
24/41
12 - 24
Whats Project Ls IRR?
10 8060
0 1 2 3IRR = ?
-100.00
PV3
PV2PV1
0 = NPVEnter CFj in CF, then press IRR:
IRRL = 18.13%. IRRS = 23.56%.
7/31/2019 Ch 12 Capital Budgeting
25/41
12 - 25
40 4040
0 1 2 3IRR = ?
Find IRR if CFs are constant:
-100
Or, with CF, enter CFj and pressIRR = 9.70%.
3 -100 40 0
9.70%
INPUTS
OUTPUT
N COMP i% PV PMT FV
7/31/2019 Ch 12 Capital Budgeting
26/41
12 - 26
90 109090
0 1 2 10IRR = ?
Q. How is a projects IRRrelated to a bonds YTM?
A. They are the same thing.A bonds YTM is the IRRif you invest in the bond.
-1134.2
IRR = 7.08%
...
7/31/2019 Ch 12 Capital Budgeting
27/41
12 - 27
Rationale for the IRR Method
If IRR > WACC, then the projects
rate of return is greater than itscost--some return is left over toboost stockholders returns.
Example: WACC = 10%, IRR = 15%.Profitable.
7/31/2019 Ch 12 Capital Budgeting
28/41
12 - 28
IRR Acceptance Criteria
If IRR > k, accept project.
If IRR < k, reject project.
7/31/2019 Ch 12 Capital Budgeting
29/41
12 - 29
Decisions on Projects S and L per IRR
If S and L are independent, accept
both. IRRs > k = 10%.
If S and L are mutually exclusive,accept S because IRRS > IRRL .
7/31/2019 Ch 12 Capital Budgeting
30/41
12 - 30
Construct NPV Profiles
Enter CFs in CFLO and find NPVL andNPVS at different discount rates:
k0
5
1015
20
NPVL50
33
197
(4
NPVS40
29
2012
5(4)
7/31/2019 Ch 12 Capital Budgeting
31/41
12 - 31
-10
0
10
20
30
40
50
60
5 10 15 20 23.6
NPV ($)
Discount Rate (%)
IRRL = 18.1%
IRRS = 23.6%
CrossoverPoint = 8.7%
k
0
5
10
15
20
NPVL50
33
19
7
(4)
NPVS40
29
20
12
5
S
L
.
.
...
.
.
. .
..
7/31/2019 Ch 12 Capital Budgeting
32/41
12 - 32
NPV and IRR always lead to the sameaccept/reject decision for independent
projects:
k > IRR
and NPV < 0.Reject.
NPV ($)
k (%)IRR
IRR > k
and NPV > 0Accept.
7/31/2019 Ch 12 Capital Budgeting
33/41
12 - 33
Mutually Exclusive Projects
k 8.7 k
NPV
%
IRRS
IRRL
L
S
k < 8.7: NPVL> NPVS , IRRS > IRRLCONFLICT
k > 8.7: NPVS> NPVL , IRRS > IRRL
NO CONFLICT
7/31/2019 Ch 12 Capital Budgeting
34/41
12 - 34
To Find the Crossover Rate
1. Find cash flow differences betweenthe projects. See data at beginningof the case.
2. Enter these differences in CFLOregister, then press IRR. Crossoverrate = 8.68%, rounded to 8.7%.
3. Can subtract S from L or vice versa,but better to have first CF negative.
4. If profiles dont cross, one projectdominates the other.
12 35
7/31/2019 Ch 12 Capital Budgeting
35/41
12 - 35
YearProject
LProject
SL-S
Cross
over
0 (100) (100) 0
1 10 70 -60
2 60 50 10
3 80 20 60 8.68%
To Find the Crossover Rate
12 36
7/31/2019 Ch 12 Capital Budgeting
36/41
12 - 36
Two Reasons NPV Profiles Cross
1. Size (scale) differences. Smallerproject frees up funds at t = 0 for
investment. The higher the opportunitycost, the more valuable these funds, sohigh k favors small projects.
2. Timing differences. Project with fasterpayback provides more CF in earlyyears for reinvestment. If k is high,early CF especially good, NPVS > NPVL.
12 37
7/31/2019 Ch 12 Capital Budgeting
37/41
12 - 37
Reinvestment Rate Assumptions
NPV assumes reinvest at k(opportunity cost of capital).
IRR assumes reinvest at IRR.
Reinvest at opportunity cost, k, ismore realistic, so NPV method isbest. NPV should be used to choosebetween mutually exclusive projects.
12 38
7/31/2019 Ch 12 Capital Budgeting
38/41
12 - 38
Managers like rates--prefer IRR to NPVcomparisons. Can we give them a
better IRR?
Yes, MIRR is the discount rate that
causes the PV of a projects terminalvalue (TV) to equal the PV of costs.TV is found by compounding inflowsat WACC.
Thus, MIRR assumes cash inflows arereinvested at WACC.
12 39
7/31/2019 Ch 12 Capital Budgeting
39/41
12 - 39
MIRR = 16.5%
10.0 80.060.0
0 1 2 310%
66.012.1
158.1
MIRR for Project L (k = 10%)
-100.0
10%10%
TV inflows
-100.0
PV outflowsMIRRL = 16.5%
$-100=
$158.1(1 + MIRRL)
30
12 40
7/31/2019 Ch 12 Capital Budgeting
40/41
12 - 40
To find TV with Casio, enter in CFLO:
i% = 10
RCL NPV = 118.78 = PV of inflows.Enter PV = -118.78, n = 3, i% = 10, PMT = 0.Press COMP FV = 158.10 = FV of inflows.
Enter FV = 158.10, PV = -100, PMT = 0,n = 3.Press COMP i% = 16.50% = MIRR.
CF0 = 0, CF1 = 10, CF2 = 60, CF3 =80
12 41
7/31/2019 Ch 12 Capital Budgeting
41/41
12 - 41
Why use MIRR versus IRR?
MIRR correctly assumes reinvestment
at opportunity cost = WACC. MIRRalso avoids the problem of multipleIRRs.
Managers like rate of returncomparisons, and MIRR is better forthis than IRR.