CAPITAL BUDGETING tài liệu, giáo án, bài giảng , luận văn, luận án, đồ án, bài tập lớn về tất cả các lĩnh vực kinh tế, k...
CAPITAL BUDGETING What it is • Large investment in plant or equipment with returns over a period of time. • Investment may take place over a period of time • A Strategic Investment Decision 1 CAPITAL BUDGETING Purpose • Expansion • Improvement • Replacement • R&D 2 CAPITAL BUDGETING What do we need to think about? • Location • Infrastructure • Labour • Cash Flows What is the most important? 3 OVERALL AIM To maximise shareholders wealth.. Projects should give a return over and above the marginal weighted average cost of capital. Projects can be; • Mutually exclusive • Independent • Contingent Process of Choice 4 IDEAL SELECTION METHOD • • • • Will Select the project that maximises shareholders wealth Consider all cash flows Discount the cash flows at the appropriate market determined opportunity cost of capital Will allow managers to consider each project independently from all others 5 SELECTION METHODS • Payback • ARR • Net Present Value (NPV) • Internal Rate of Return (IRR) 6 CHOICE PAYBACK Project A Yr 0 - 1,000,000 Yr 1 + 1,100,000 Yr 2 + 200,000 Yr 3 100,000 + + + Project B 1,000,000 500,000 500,000 500,000 Project A = Year .909 Project B = ? 7 PAYBACK Problems:• Ignores overall return • Ignores impact of large flows • Ignores timing of flows 8 ARR Project A Yr 0 - 1,000,000 Yr 1 + 1,100,000 Yr 2 + 200,000 Yr 3 100,000 RoA Project A • + + + = Project B 1,000,000 500,000 500,000 500,000 n Σ ( cashflows) ÷ Io t=o n (200,000) = 66,666.66 ÷ 1,000,000 = .0666 or 6.67% 3 Project B? Problems? 9 NET PRESENT VALUE PROJECT A Yr 0 1 2 3 4 5 CF - 1,000,000 500,000 500,000 500,000 500,000 - 500,000 PV Factor @ 14% 1.000 .8772 .7695 .6750 .5921 .5194 Present Value - 1,000,000 438,600 384,750 337,500 296,050 - 259,700 NPV 197,200 10 NET PRESENT VALUE PROJECT B - 1,000,000 900,000 200,000 200,000 100,000 100,000 11 NET PRESENT VALUE PROJECT B - 1,000,000 900,000 200,000 200,000 100,000 100,000 - 1,000,000 789,480 153,900 135,000 59,210 51,940 NPV 189,530 Which project should we undertake? Why? 12 Internal Rate of Return Project A Yr 0 1 2 3 4 5 CF -1,000,000 500,000 500,000 500,000 500,000 - 500,000 PVF@ 26% PV 1.0000 = - 1,000,000 .793651 = 396,825 .629881 = 314,941 .499906 = 249,953 .396751 = 198,376 .314881 = - 157,441 2,654 PVF@ 27% 1.0000 - 1,000,000 .787401 393,701 .620001 310,000 .488190 244,095 .384401 192,200 .302678 -151,339 -11,343 Interpolation IRR = 26.19% Project B 0 -1,000,000 1 900,000 2 200,000 3 200,000 4 100,000 5 100,000 IRR = 27% 1.0000 = - 1,000,000 = 714,286 = 125,976 = 99,981 = 39,675 = 31,488 11,406 1.0000 - 1,000,000 708,661 124,002 97,638 38,440 30,268 - 991 13 Interpolation 26% 27% +2,654 -11,343 13,997 Q. Where on the line does 0 fall? From + 2654 0 = 2654 = .1896 or 18.96% of distance 13997 Since distance = 27-26 ∴ Answer = 26 + .1896 = 1% = .1896 of 1% = 26.19% 14 Test @ 26.19% Yr CF PVIF PV 0 - 1,000,000 1.0000 -1,000,000 1 500,000 .7924558 396,228 2 500,000 .6279862 313,993 3 500,000 .4976513 248,826 4 500,000 .3943667 197,183 5 - 500,000 .3125182 - 156,259 - 29 15 Comparison of NPV vs. IRR 1. NPV accepts all projects with NPV > 0. Ranking of projects is by value of NPV. 2. IRR finds the value of the discount rate that makes NPV = 0. Project will be accepted if IRR > k (cost of capital) The big Q? Will the two methods always give the same answer? No, unfortunately not 16 NPV Vs IRR Relationship between NPV,IRR and Discount Rates 0 10 20 30 40 50 Disc rate NPV 17 Yr CF 1 400 2 400 3 - 1,000 PV@10% 363.6 330.4 - 751.0 - 57 PV@20% 333.3 277.76 - 578.70 32.4 IRR = 15.8% 18 Reinvestment Rate Assumption Project Yr0 X -10,000 Y -10,000 Yr1 5,000 0 Yr2 5,000 0 Yr3 C of K 5,000 10% 17,280 10% NPV IRR 2,430 23.4% 2,977 20.0% Illustration Reinvestment @23.4% @ 10% End Yr 1 5,000 End Yr 2 6,170 5,000 End Yr 3 7,613 6,170 5,000 18,783 5,000 5,500 5,000 6,050 5,500 5,000 16,550 19 Value Additivity Project 1 2 3 1+3 2+3 NPV @10% 354 104 309 663 413 IRR% 134.5 125.0 350.0 212.8 237.5 20 Multiple Rates of Return • Multiple Rates of Return NPV 400 200 IRR 15% Discount Rate 0 IRR – 12% - 200 - 400 21 NPV Vs IRR Conclusion NPV is the correct method to use But - there are some additional issues 22 Other Issues • Scale How do we evaluate between projects of different scale? Project Outlay PV @ 10 % NPV A - 400 572 172 B - 500 683 183 How do we compare? If we have plenty of capital then it is not a problem. Both have a positive NPV so do both. 23 Other Issues Scale • Suppose we only have 600 worth of capital. Which project should we take? • Work out the Profitability Index Present Value = PI Cost • Project A = 572 = 1.43 400 Project B = 683 = 1.37 500 24 Other Issues Scale • Now work out the weighted PI • For A (1.43 x 400) + (1 x 200) = 1.2866 600 600 .9533 .3333 For B (1.37 x 500) + (1 x 100) = 1.3084 600 600 Therefore take Project B 25 Other Issues Project Lives • What if projects take place over different time scales? Yr Project A Project B 0 - 17,500 -17,500 1 10,500 7,000 2 10,500 7,000 3 8,313 NPV @ 10% 723 894 26 Other Issues Project Lives • • How to choose Assume you are able to repeat the projects until they have the same end date 0 2 4 6A 3 B 723 597 493 1813 723 (discount at 10%) 723 (discount at 10%) 27 Project Lives • Project B 0 2 4 6 3 894 672 1566 894 (discount at 10%) 28 Project Lives • This approach is fine for simple project lives but what if they are complex? • E.g.lives of 7 years, 9 years and 13 years • Answer make them all last for ever! • NPV(n, to inf) = NPVn (1+ k)n (1+ k)n – 1 29 Project Lives • E.g. NPV2 to inf = 723 (1.1)2 = 723 x 1.21 (1.1)2 - 1 723 x 5.76 = 4,165 .21 NPV3 to inf = 894 (1.1)3 = 894 x 1.331 • (1.1)3 – 1 894 x 4.02 = 3,596 .331 30 Cash Flows Example – Consider the following new project:Initial capital investment of £15m. It will generate sales for 5 years. Variable Costs equal 70% of sales. Fixed cost of project =£200,000 P.A. A feasibility study, cost £5000, has already been carried out. Discount rate = 12%. Should we take the project? 31 Cash Flows £000's 2000 2001 2002 2003 2004 2005 SALES 14000 16000 18000 20000 22000 90000 VARIABLE COSTS -9800 -11200 -12600 -14000 -15400 -63000 -200 -200 -200 -200 -200 -1000 OPERATING EXPENSES EQUIPMENT COSTS -15000 CASHFLOWS -15000 4000 4600 5200 5800 6400 1.00 0.893 0.797 0.712 0.636 0.567 -15000 3571 3667 3701 3686 3632 1.00 0.84 0.70 0.58 0.49 0.41 -15000 3340 3208 3028 2820 2599 DF @ 12% NPV 19.75 IRR = 19.75% -15000 11000 3257 -4 32 Cash Flows Treatment of depreciation in NPV analysis. -We only use cashflows in investment appraisal. -Depreciation is not a cashflow. -However, depreciation (capital allowances) is allowable against tax (see income statement), which affects cashflow. For cashflow, add depreciation back:- 33 Treatment of Depreciation £000's 2000 2001 2002 2003 2004 2005 SALES 14000 16000 18000 20000 22000 90000 VARIABLE COSTS -9800 -11200 -12600 -14000 -15400 -63000 -200 -200 -200 -200 -200 -1000 OPERATING EXPENSES EQUIPMENT COSTS -15000 DEPRECIATION NOI -15000 NOI AFTER TAX ADD BACK DEPN (= NCF) DF @ 12% NPV DF 16.35 -15000 -3000 1000 800 3800 -3000 1600 1280 4280 -3000 2200 1760 4760 -3000 2800 2240 5240 -3000 3400 2720 5720 11000 8800 23800 1.00 -15000 0.893 3393 0.797 3412 0.712 3388 0.636 3330 0.567 3246 1769 -15000 1.00 3266 0.86 3162 0.74 3022 0.63 2859 0.55 2683 0.47 -8 34 Issues to Consider Cash Flows • But not in detail! • Cash flows should be incremental - include all incidental effects (redundancy) - Do not forget working capital - Do forget sunk costs! - Be careful with allocated overheads 35 Issues to Consider Cash Flows • ‘Uncertainty means more things can happen than will happen’ Brealy and Myers. • How do we obtain a feel for what the cash flows are most likely to be? • - Sensitivity Analysis • - Scenario Analysis • - Break Even Analysis • - Simulation • - Decision Trees 36 Issues to Consider Discount Rate • We also need to consider what discount rate to use as this will also effect the outcome. • This is the next subject 37 [...]... between projects of different scale? Project Outlay PV @ 10 % NPV A - 400 572 172 B - 500 683 183 How do we compare? If we have plenty of capital then it is not a problem Both have a positive NPV so do both 23 Other Issues Scale • Suppose we only have 600 worth of capital Which project should we take? • Work out the Profitability Index Present Value = PI Cost • Project A = 572 = 1.43 400 Project B =... of NPV vs IRR 1 NPV accepts all projects with NPV > 0 Ranking of projects is by value of NPV 2 IRR finds the value of the discount rate that makes NPV = 0 Project will be accepted if IRR > k (cost of capital) The big Q? Will the two methods always give the same answer? No, unfortunately not 16 NPV Vs IRR Relationship between NPV,IRR and Discount Rates 0 10 20 30 40 50 Disc rate NPV 17 Yr CF 1 400 2... = 723 (1.1)2 = 723 x 1.21 (1.1)2 - 1 723 x 5.76 = 4,165 21 NPV3 to inf = 894 (1.1)3 = 894 x 1.331 • (1.1)3 – 1 894 x 4.02 = 3,596 331 30 Cash Flows Example – Consider the following new project:Initial capital investment of £15m It will generate sales for 5 years Variable Costs equal 70% of sales Fixed cost of project =£200,000 P.A A feasibility study, cost £5000, has already been carried out Discount... NPV 19.75 IRR = 19.75% -15000 11000 3257 -4 32 Cash Flows Treatment of depreciation in NPV analysis -We only use cashflows in investment appraisal -Depreciation is not a cashflow -However, depreciation (capital allowances) is allowable against tax (see income statement), which affects cashflow For cashflow, add depreciation back:- 33 Treatment of Depreciation £000's 2000 2001 2002 2003 2004 2005 SALES... 3162 0.74 3022 0.63 2859 0.55 2683 0.47 -8 34 Issues to Consider Cash Flows • But not in detail! • Cash flows should be incremental - include all incidental effects (redundancy) - Do not forget working capital - Do forget sunk costs! - Be careful with allocated overheads 35 Issues to Consider Cash Flows • ‘Uncertainty means more things can happen than will happen’ Brealy and Myers • How do we obtain .. .CAPITAL BUDGETING Purpose • Expansion • Improvement • Replacement • R&D CAPITAL BUDGETING What we need to think about? • Location • Infrastructure... we compare? If we have plenty of capital then it is not a problem Both have a positive NPV so both 23 Other Issues Scale • Suppose we only have 600 worth of capital Which project should we take?... all cash flows Discount the cash flows at the appropriate market determined opportunity cost of capital Will allow managers to consider each project independently from all others SELECTION METHODS