1 chapter 6: analyzing investment projects copyright © prentice hall inc. 2000. author: nick...
DESCRIPTION
3 Objectives To show how to use discounted cash flow analysis to make decisions such as:To show how to use discounted cash flow analysis to make decisions such as: –Whether to enter a new line of business –Whether to invest in equipment to reduce costsTRANSCRIPT
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Chapter 6: Analyzing Chapter 6: Analyzing Investment ProjectsInvestment Projects
Copyright © Prentice Hall Inc. 2000. Author: Nick Bagley, bdellaSoft, Inc.
ObjectiveExplain Capital Budgeting
Develop Criteria
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Chapter 6 ContentsChapter 6 Contents
• 1 The Nature of Project 1 The Nature of Project AnalysisAnalysis
• 2 Where do Investments 2 Where do Investments Ideas come from?Ideas come from?
• 3 The NPV Investment Rule3 The NPV Investment Rule• 4 Estimating a Project.s 4 Estimating a Project.s
Cash FlowsCash Flows• 5 Cost of Capital5 Cost of Capital• 6 Sensitivity Analysis6 Sensitivity Analysis
• 7 Analyzing Cost-7 Analyzing Cost-Reducing ProjectsReducing Projects
• 8 Projects with Different 8 Projects with Different LivesLives
• 9 Ranking Mutually 9 Ranking Mutually Exclusive ProjectsExclusive Projects
• 10 Inflation & Capital 10 Inflation & Capital BudgetingBudgeting
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ObjectivesObjectives
• To show how to use discounted cash To show how to use discounted cash flow analysis to make decisions flow analysis to make decisions such as:such as:– Whether to enter a new line of Whether to enter a new line of
businessbusiness– Whether to invest in equipment to Whether to invest in equipment to
reduce costsreduce costs
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NPV of a Project
Discout 10%
Year Flow PV Cum_PV0 -1000 -1000 -10001 450 409 -5912 350 289 -3023 250 188 -1144 150 102 -115 50 31 20
NPV 20 Do Project DCF Payback
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NPV of a Project
Discout 15%
Year Flow PV Cum_PV0 -1000 -1000 -10001 450 391 -6092 350 265 -3443 250 164 -1804 150 86 -945 50 25 -69
NPV -69
Don’t Do Project
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NPV of a Project
Discout 11.04%
Year Flow PV Cum_PV0 -1000 -1000 -10001 450 405 -5952 350 284 -3113 250 183 -1284 150 99 -305 50 30 0
NPV 0 Indifferent
Internal Rate of Return
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NPV as a Function of Discount Rate
-200
-150
-100
-50
0
50
100
150
200
250
0% 5% 10% 15% 20%
Discount Rate
NPV
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Average Cost of Capital: Average Cost of Capital: Example with 3-SecuritiesExample with 3-Securities• LetLet
• kkee be the return on equity be the return on equity• kkdd be the return on debt be the return on debt• kkpp be the return on preferred be the return on preferred• VVee be the market value of issued equity be the market value of issued equity• VVdd be the Market value of issued bonds be the Market value of issued bonds• VVpp be the market value of issued preferred be the market value of issued preferred• t be the tax ratet be the tax rate
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Average Cost of Capital: Average Cost of Capital: Example with 3-SecuritiesExample with 3-Securities
• k = kk = kee * V * Vee + k + kpp * V * Vpp + k + kdd * V * Vdd* (1 - * (1 - t)t)
• The average cost of capital is also The average cost of capital is also the cost of capital for each of the the cost of capital for each of the firms business divisions weighted firms business divisions weighted according to their market valueaccording to their market value
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Tax rate 40.00%Unit sales in year 1 $4,000Sales growth rate 0.00%Unit price $5,000Unit Price Growth 0.00%Fixed Start 3,100,000Fixed Growth 0.00%Variable pcent 75.00%Depreciation schedule 400,000 NPV = 1236Start working capt 2,200,000Investment schedule 2,800,000Capital movements sch 0Dividend 1,000,000Working Cap Sch 2,200,000
Year 0 1 2 3 4 5 6 7CF ForecastSales revenue 20,000 20,000 20,000 20,000 20,000 20,000 20,000ExpensesFixed Costs (cash) 3,100 3,100 3,100 3,100 3,100 3,100 3,100Variable costs 15,000 15,000 15,000 15,000 15,000 15,000 15,000Depreciation 400 400 400 400 400 400 400Operating Profit 1,500 1,500 1,500 1,500 1,500 1,500 1,500Taxes 600 600 600 600 600 600 600Net Profit 900 900 900 900 900 900 900Operating CF 1,300 1,300 1,300 1,300 1,300 1,300 1,300Working cap move 2200 -2,200Investment in P&E 2,800 0 0 0 0 0 0Invest CF 5,000 0 0 0 0 0 0 -2,200Net CF -5,000 1,300 1,300 1,300 1,300 1,300 1,300 3,500PV(NCF) -5000 1130 983 855 743 646 562 1316
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Assumptions (Table in $'000)Cost of capital 15.00%Tax rate 40.00%Unit sales in year 1 $4,000Sales growth rate 2.00%Unit price $5,000Unit Price Growth -3.00%Fixed Start 3,100,000Fixed Growth 8.00%Variable pcent 75.00%Depreciation schedule 400,000 NPV = -797Start working capt 2,200,000Investment schedule 2,800,000Capital movements sch 0Dividend 1,000,000Working Cap Sch 2,200,000
Year 0 1 2 3 4 5 6 7CF ForecastSales revenue 20,000 19,788 19,578 19,371 19,165 18,962 18,761ExpensesFixed Costs (cash) 3,100 3,348 3,616 3,905 4,218 4,555 4,919Variable costs 15,000 14,841 14,684 14,528 14,374 14,222 14,071Depreciation 400 400 400 400 400 400 400Operating Profit 1,500 1,199 879 538 174 -214 -629Taxes 600 480 351 215 70 -86 -252Net Profit 900 719 527 323 104 -129 -377Operating CF 1,300 1,119 927 723 504 271 23Working cap move 2200 -2,200Investment in P&E 2,800 0 0 0 0 0 0Invest CF 5,000 0 0 0 0 0 0 -2,200Net CF -5,000 1,300 1,119 927 723 504 271 2,223PV(NCF) -5000 1130 846 610 413 251 117 836
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Assumptions (Table in $'000)Cost of capital 25.00%Tax rate 40.00%Unit sales in year 1 $4,000Sales growth rate 0.00%Unit price $5,000Unit Price Growth 0.00%Fixed Start 3,100,000Fixed Growth 0.00%Variable pcent 75.00%Depreciation schedule 400,000 NPV = -429Start working capt 2,200,000Investment schedule 2,800,000Capital movements sch 0Dividend 1,000,000Working Cap Sch 2,200,000
Year 0 1 2 3 4 5 6 7CF ForecastSales revenue 20,000 20,000 20,000 20,000 20,000 20,000 20,000ExpensesFixed Costs (cash) 3,100 3,100 3,100 3,100 3,100 3,100 3,100Variable costs 15,000 15,000 15,000 15,000 15,000 15,000 15,000Depreciation 400 400 400 400 400 400 400Operating Profit 1,500 1,500 1,500 1,500 1,500 1,500 1,500Taxes 600 600 600 600 600 600 600Net Profit 900 900 900 900 900 900 900Operating CF 1,300 1,300 1,300 1,300 1,300 1,300 1,300Working cap move 2200 -2,200Investment in P&E 2,800 0 0 0 0 0 0Invest CF 5,000 0 0 0 0 0 0 -2,200Net CF -5,000 1,300 1,300 1,300 1,300 1,300 1,300 3,500PV(NCF) -5000 1040 832 666 532 426 341 734
Was 15%
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Assumptions (Table in $'000)Cost of capital 15.00%Tax rate 30.00%Unit sales in year 1 $4,000Sales growth rate 0.00%Unit price $5,000Unit Price Growth 0.00%Fixed Start 3,100,000Fixed Growth 0.00%Variable pcent 75.00%Depreciation schedule 400,000 NPV = 1860Start working capt 2,200,000Investment schedule 2,800,000Capital movements sch 0Dividend 1,000,000Working Cap Sch 2,200,000
Year 0 1 2 3 4 5 6 7CF ForecastSales revenue 20,000 20,000 20,000 20,000 20,000 20,000 20,000ExpensesFixed Costs (cash) 3,100 3,100 3,100 3,100 3,100 3,100 3,100Variable costs 15,000 15,000 15,000 15,000 15,000 15,000 15,000Depreciation 400 400 400 400 400 400 400Operating Profit 1,500 1,500 1,500 1,500 1,500 1,500 1,500Taxes 450 450 450 450 450 450 450Net Profit 1,050 1,050 1,050 1,050 1,050 1,050 1,050Operating CF 1,450 1,450 1,450 1,450 1,450 1,450 1,450Working cap move 2200 -2,200Investment in P&E 2,800 0 0 0 0 0 0Invest CF 5,000 0 0 0 0 0 0 -2,200Net CF -5,000 1,450 1,450 1,450 1,450 1,450 1,450 3,650PV(NCF) -5000 1261 1096 953 829 721 627 1372
Was 40%
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Assumptions (Table in $'000)Cost of capital 15.00%Tax rate 40.00%Unit sales in year 1 $4,000Sales growth rate 5.00%Unit price $5,000Unit Price Growth 0.00%Fixed Start 3,100,000Fixed Growth 0.00%Variable pcent 75.00%Depreciation schedule 400,000 NPV = 2885Start working capt 2,200,000Investment schedule 2,800,000Capital movements sch 0Dividend 1,000,000Working Cap Sch 2,200,000
Year 0 1 2 3 4 5 6 7CF ForecastSales revenue 20,000 21,000 22,050 23,153 24,310 25,526 26,802ExpensesFixed Costs (cash) 3,100 3,100 3,100 3,100 3,100 3,100 3,100Variable costs 15,000 15,750 16,538 17,364 18,233 19,144 20,101Depreciation 400 400 400 400 400 400 400Operating Profit 1,500 1,750 2,013 2,288 2,578 2,881 3,200Taxes 600 700 805 915 1,031 1,153 1,280Net Profit 900 1,050 1,208 1,373 1,547 1,729 1,920Operating CF 1,300 1,450 1,608 1,773 1,947 2,129 2,320Working cap move 2200 -2,200Investment in P&E 2,800 0 0 0 0 0 0Invest CF 5,000 0 0 0 0 0 0 -2,200Net CF -5,000 1,300 1,450 1,608 1,773 1,947 2,129 4,520PV(NCF) -5000 1130 1096 1057 1014 968 920 1699
Was 0%
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Assumptions (Table in $'000)Cost of capital 15.00%Tax rate 40.00%Unit sales in year 1 $4,000Sales growth rate 0.00%Unit price $5,000Unit Price Growth 0.00%Fixed Start 3,100,000Fixed Growth 0.00%Variable pcent 85.00%Depreciation schedule 400,000 NPV = -3757Start working capt 2,200,000Investment schedule 2,800,000Capital movements sch 0Dividend 1,000,000Working Cap Sch 2,200,000
Year 0 1 2 3 4 5 6 7CF ForecastSales revenue 20,000 20,000 20,000 20,000 20,000 20,000 20,000ExpensesFixed Costs (cash) 3,100 3,100 3,100 3,100 3,100 3,100 3,100Variable costs 17,000 17,000 17,000 17,000 17,000 17,000 17,000Depreciation 400 400 400 400 400 400 400Operating Profit -500 -500 -500 -500 -500 -500 -500Taxes -200 -200 -200 -200 -200 -200 -200Net Profit -300 -300 -300 -300 -300 -300 -300Operating CF 100 100 100 100 100 100 100Working cap move 2200 -2,200Investment in P&E 2,800 0 0 0 0 0 0Invest CF 5,000 0 0 0 0 0 0 -2,200Net CF -5,000 100 100 100 100 100 100 2,300PV(NCF) -5000 87 76 66 57 50 43 865
Was 75%
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Assumptions (Table in $'000)Cost of capital 15.00%Tax rate 40.00%Unit sales in year 1 $4,000Sales growth rate 0.00%Unit price $5,000Unit Price Growth 0.00%Fixed Start 3,500,000Fixed Growth 0.00%Variable pcent 75.00%Depreciation schedule 400,000 NPV = 237Start working capt 2,200,000Investment schedule 2,800,000Capital movements sch 0Dividend 1,000,000Working Cap Sch 2,200,000
Year 0 1 2 3 4 5 6 7CF ForecastSales revenue 20,000 20,000 20,000 20,000 20,000 20,000 20,000ExpensesFixed Costs (cash) 3,500 3,500 3,500 3,500 3,500 3,500 3,500Variable costs 15,000 15,000 15,000 15,000 15,000 15,000 15,000Depreciation 400 400 400 400 400 400 400Operating Profit 1,100 1,100 1,100 1,100 1,100 1,100 1,100Taxes 440 440 440 440 440 440 440Net Profit 660 660 660 660 660 660 660Operating CF 1,060 1,060 1,060 1,060 1,060 1,060 1,060Working cap move 2200 -2,200Investment in P&E 2,800 0 0 0 0 0 0Invest CF 5,000 0 0 0 0 0 0 -2,200Net CF -5,000 1,060 1,060 1,060 1,060 1,060 1,060 3,260PV(NCF) -5000 922 802 697 606 527 458 1226
Was $3,100,000
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Table 6.4 Project Sensitivity to Sales Table 6.4 Project Sensitivity to Sales VolumeVolume
Sales Units Net CF Operations NPV Project2000 200000 50050223000 550000 18847083604 1003009 04000 1300000 12356075000 2050000 43559226000 2800000 7476237
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NPV v. Discount Rate
$3,000
$2,000
$1,000
$0
$1,000
$2,000
$3,000
$4,000
$5,000
$6,000
$7,000
0% 5% 10% 15% 20% 25% 30% 35% 40% 45% 50%
Rate
NPV
$000
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Sensitivity of Project to Sale Volume
$500,000
$0
$500,000
$1,000,000
$1,500,000
$2,000,000
$2,500,000
$3,000,000
$2,000 $2,500 $3,000 $3,500 $4,000 $4,500 $5,000 $5,500 $6,000
Sales (Units)
Net C
F fro
m O
pera
tions
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NPV Project
$6,000,000
$4,000,000
$2,000,000
$0
$2,000,000
$4,000,000
$6,000,000
$8,000,000
$10,000,000
2000 2500 3000 3500 4000 4500 5000 5500 6000
Sales (Units)
NPV
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Schedule of Bdella Price & Maint
Age Price Maint Intang0 20,000 01 16,000 0 1,0002 12,800 1,000 8003 10,240 1,100 04 8,192 1,210 -5005 4,096 1,331 -6006 2,048 1,464 -8407 1,024 1,611 -1,1768 512 1,772 -1,6469 256 1,949 -2,305
10 128 2,144 -3,227
Discount 5.00%
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Schedule of Bdella Price & Maint
Age Price Maint Intang PV_Price PV_Maint PV_Intang PV_Proj0 20,000 0 20,0001 16,000 0 1,000 15,238 0 952 -3,8102 12,800 1,000 800 11,610 907 726 -7,6193 10,240 1,100 0 8,846 950 0 -11,3344 8,192 1,210 -500 6,740 995 -411 -14,8465 4,096 1,331 -600 3,209 1,043 -470 -19,8906 2,048 1,464 -840 1,528 1,093 -627 -23,2907 1,024 1,611 -1,176 728 1,145 -836 -26,0718 512 1,772 -1,646 347 1,199 -1,114 -28,7669 256 1,949 -2,305 165 1,256 -1,486 -31,689
10 128 2,144 -3,227 79 1,316 -1,981 -35,073
Discount 5.00%
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Schedule of Bdella Price & Maint
Age Price Maint Intang PV_Price PV_Maint PV_Intang PV_Proj Rate PV_Infinity Ann_Equ0 20,000 0 20,0001 16,000 0 1,000 15,238 0 952 -3,810 5.00% -80,000 -3,8102 12,800 1,000 800 11,610 907 726 -7,619 10.25% -81,951 -3,9023 10,240 1,100 0 8,846 950 0 -11,334 15.76% -83,236 -3,9644 8,192 1,210 -500 6,740 995 -411 -14,846 21.55% -83,738 -3,9885 4,096 1,331 -600 3,209 1,043 -470 -19,890 27.63% -91,881 -4,3756 2,048 1,464 -840 1,528 1,093 -627 -23,290 34.01% -91,771 -4,3707 1,024 1,611 -1,176 728 1,145 -836 -26,071 40.71% -90,112 -4,2918 512 1,772 -1,646 347 1,199 -1,114 -28,766 47.75% -89,013 -4,2399 256 1,949 -2,305 165 1,256 -1,486 -31,689 55.13% -89,167 -4,246
10 128 2,144 -3,227 79 1,316 -1,981 -35,073 62.89% -90,841 -4,326
Discount 5.00%