Corporate finance chapter 06 analyzing investment projects

Chapter 6: Analyzing Investment Projects Objective Explain Capital Budgeting Develop Criteria Chapter Contents • The Nature of Project Analysis • Analyzing Cost-Reducing Projects • Where Investments Ideas come from? • Projects with Different Lives • The NPV Investment Rule • Ranking Mutually Exclusive Projects • Estimating a Project.s Cash Flows • Cost of Capital • 10 Inflation & Capital Budgeting • Sensitivity Analysis Objectives • 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 costs NPV of a Project Discout 10% Year DCF Payback Flow PV Cum_PV -1000 -1000 -1000 450 409 -591 350 289 -302 250 188 -114 150 102 -11 50 31 20 NPV 20 Do Project NPV of a Project Discout 15% Year Flow PV Cum_PV -1000 -1000 -1000 450 391 -609 350 265 -344 250 164 -180 150 86 -94 50 25 -69 NPV -69 Don’t Do Project Internal Rate of Return NPV of a Project Discout 11.04% Year Flow PV Cum_PV -1000 -1000 -1000 450 405 -595 350 284 -311 250 183 -128 150 99 -30 50 30 NPV Indifferent NPV as a Function of Discount Rate 250 200 150 NPV 100 50 -50 0% 5% 10% 15% -100 -150 -200 Discount Rate 20% Average Cost of Capital: Example with 3-Securities • Let • ke be the return on equity • kd be the return on debt • kp be the return on preferred • Ve be the market value of issued equity • Vd be the Market value of issued bonds • Vp be the market value of issued preferred • t be the tax rate Average Cost of Capital: Example with 3-Securities • k = ke * Ve + kp * Vp + kd * Vd* (1 - t) • The average cost of capital is also the cost of capital for each of the firms business divisions weighted according to their market value Tax rate Unit sales in year Sales growth rate Unit price Unit Price Growth Fixed Start Fixed Growth Variable pcent Depreciation schedule Start working capt Investment schedule Capital movements sch Dividend Working Cap Sch Year CF Forecast Sales revenue Expenses Fixed Costs (cash) Variable costs Depreciation Operating Profit Taxes Net Profit Operating CF Working cap move Investment in P&E Invest CF Net CF PV(NCF) 40.00% $4,000 0.00% $5,000 0.00% 3,100,000 0.00% 75.00% 400,000 2,200,000 2,800,000 1,000,000 2,200,000 2200 2,800 5,000 -5,000 -5000 NPV = 1236 20,000 20,000 20,000 20,000 20,000 20,000 20,000 3,100 15,000 400 1,500 600 900 1,300 3,100 15,000 400 1,500 600 900 1,300 3,100 15,000 400 1,500 600 900 1,300 3,100 15,000 400 1,500 600 900 1,300 3,100 15,000 400 1,500 600 900 1,300 3,100 15,000 400 1,500 600 900 1,300 1,300 1130 0 1,300 983 0 1,300 855 0 1,300 743 0 1,300 646 0 1,300 562 3,100 15,000 400 1,500 600 900 1,300 -2,200 -2,200 3,500 1316 10 Assumptions Cost of capital Tax rate Unit sales in year Sales growth rate Unit price Unit Price Growth Fixed Start Fixed Growth Variable pcent Depreciation schedule Start working capt Investment schedule Capital movements sch Dividend Working Cap Sch Year CF Forecast Sales revenue Expenses Fixed Costs (cash) Variable costs Depreciation Operating Profit Taxes Net Profit Operating CF Working cap move Investment in P&E Invest CF Net CF PV(NCF) (Table in $'000) 15.00% 40.00% $4,000 2.00% $5,000 -3.00% 3,100,000 8.00% 75.00% 400,000 2,200,000 2,800,000 1,000,000 2,200,000 2200 2,800 5,000 -5,000 -5000 NPV = -797 20,000 19,788 19,578 19,371 19,165 18,962 18,761 3,100 15,000 400 1,500 600 900 1,300 3,348 14,841 400 1,199 480 719 1,119 3,616 14,684 400 879 351 527 927 3,905 14,528 400 538 215 323 723 4,218 14,374 400 174 70 104 504 4,555 14,222 400 -214 -86 -129 271 1,300 1130 0 1,119 846 0 927 610 0 723 413 0 504 251 0 271 117 4,919 14,071 400 -629 -252 -377 23 -2,200 -2,200 2,223 836 11 Assumptions Cost of capital Tax rate Unit sales in year Sales growth rate Unit price Unit Price Growth Fixed Start Fixed Growth Variable pcent Depreciation schedule Start working capt Investment schedule Capital movements sch Dividend Working Cap Sch Year CF Forecast Sales revenue Expenses Fixed Costs (cash) Variable costs Depreciation Operating Profit Taxes Net Profit Operating CF Working cap move Investment in P&E Invest CF Net CF PV(NCF) (Table in $'000) 25.00% 40.00% $4,000 0.00% $5,000 0.00% 3,100,000 0.00% 75.00% 400,000 2,200,000 2,800,000 1,000,000 2,200,000 2200 2,800 5,000 -5,000 -5000 Was 15% NPV = -429 20,000 20,000 20,000 20,000 20,000 20,000 20,000 3,100 15,000 400 1,500 600 900 1,300 3,100 15,000 400 1,500 600 900 1,300 3,100 15,000 400 1,500 600 900 1,300 3,100 15,000 400 1,500 600 900 1,300 3,100 15,000 400 1,500 600 900 1,300 3,100 15,000 400 1,500 600 900 1,300 1,300 1040 0 1,300 832 0 1,300 532 0 1,300 426 0 1,300 341 3,100 15,000 400 1,500 600 900 1,300 -2,200 -2,200 3,500 734 0 1,300 66612 Assumptions Cost of capital Tax rate Unit sales in year Sales growth rate Unit price Unit Price Growth Fixed Start Fixed Growth Variable pcent Depreciation schedule Start working capt Investment schedule Capital movements sch Dividend Working Cap Sch Year CF Forecast Sales revenue Expenses Fixed Costs (cash) Variable costs Depreciation Operating Profit Taxes Net Profit Operating CF Working cap move Investment in P&E Invest CF Net CF PV(NCF) (Table in $'000) 15.00% 30.00% $4,000 0.00% $5,000 0.00% 3,100,000 0.00% 75.00% 400,000 2,200,000 2,800,000 1,000,000 2,200,000 2200 2,800 5,000 -5,000 -5000 Was 40% NPV = 1860 20,000 20,000 20,000 20,000 20,000 20,000 20,000 3,100 15,000 400 1,500 450 1,050 1,450 3,100 15,000 400 1,500 450 1,050 1,450 3,100 15,000 400 1,500 450 1,050 1,450 3,100 15,000 400 1,500 450 1,050 1,450 3,100 15,000 400 1,500 450 1,050 1,450 3,100 15,000 400 1,500 450 1,050 1,450 1,450 1261 0 1,450 1096 0 1,450 953 0 1,450 829 0 1,450 721 0 1,450 627 3,100 15,000 400 1,500 450 1,050 1,450 -2,200 -2,200 3,650 1372 13 Assumptions Cost of capital Tax rate Unit sales in year Sales growth rate Unit price Unit Price Growth Fixed Start Fixed Growth Variable pcent Depreciation schedule Start working capt Investment schedule Capital movements sch Dividend Working Cap Sch Year CF Forecast Sales revenue Expenses Fixed Costs (cash) Variable costs Depreciation Operating Profit Taxes Net Profit Operating CF Working cap move Investment in P&E Invest CF Net CF PV(NCF) (Table in $'000) 15.00% 40.00% $4,000 5.00% $5,000 0.00% 3,100,000 0.00% 75.00% 400,000 2,200,000 2,800,000 1,000,000 2,200,000 2200 2,800 5,000 -5,000 -5000 Was 0% NPV = 2885 20,000 21,000 22,050 23,153 24,310 25,526 26,802 3,100 15,000 400 1,500 600 900 1,300 3,100 15,750 400 1,750 700 1,050 1,450 3,100 16,538 400 2,013 805 1,208 1,608 3,100 17,364 400 2,288 915 1,373 1,773 3,100 18,233 400 2,578 1,031 1,547 1,947 3,100 19,144 400 2,881 1,153 1,729 2,129 1,300 1130 0 1,450 1096 0 1,608 1057 0 1,773 1014 0 1,947 968 0 2,129 920 3,100 20,101 400 3,200 1,280 1,920 2,320 -2,200 -2,200 4,520 1699 14 Assumptions Cost of capital Tax rate Unit sales in year Sales growth rate Unit price Unit Price Growth Fixed Start Fixed Growth Variable pcent Depreciation schedule Start working capt Investment schedule Capital movements sch Dividend Working Cap Sch Year CF Forecast Sales revenue Expenses Fixed Costs (cash) Variable costs Depreciation Operating Profit Taxes Net Profit Operating CF Working cap move Investment in P&E Invest CF Net CF PV(NCF) (Table in $'000) 15.00% 40.00% $4,000 0.00% $5,000 0.00% 3,100,000 0.00% 85.00% 400,000 2,200,000 2,800,000 1,000,000 2,200,000 2200 2,800 5,000 -5,000 -5000 Was 75% NPV = -3757 20,000 20,000 20,000 20,000 20,000 20,000 20,000 3,100 17,000 400 -500 -200 -300 100 3,100 17,000 400 -500 -200 -300 100 3,100 17,000 400 -500 -200 -300 100 3,100 17,000 400 -500 -200 -300 100 3,100 17,000 400 -500 -200 -300 100 3,100 17,000 400 -500 -200 -300 100 100 87 0 100 76 0 100 66 0 100 57 0 100 50 0 100 43 3,100 17,000 400 -500 -200 -300 100 -2,200 -2,200 2,300 865 15 Assumptions Cost of capital Tax rate Unit sales in year Sales growth rate Unit price Unit Price Growth Fixed Start Fixed Growth Variable pcent Depreciation schedule Start working capt Investment schedule Capital movements sch Dividend Working Cap Sch Year CF Forecast Sales revenue Expenses Fixed Costs (cash) Variable costs Depreciation Operating Profit Taxes Net Profit Operating CF Working cap move Investment in P&E Invest CF Net CF PV(NCF) (Table in $'000) 15.00% 40.00% $4,000 0.00% $5,000 0.00% 3,500,000 0.00% 75.00% 400,000 2,200,000 2,800,000 1,000,000 2,200,000 2200 2,800 5,000 -5,000 -5000 Was $3,100,000 NPV = 237 20,000 20,000 20,000 20,000 20,000 20,000 20,000 3,500 15,000 400 1,100 440 660 1,060 3,500 15,000 400 1,100 440 660 1,060 3,500 15,000 400 1,100 440 660 1,060 3,500 15,000 400 1,100 440 660 1,060 3,500 15,000 400 1,100 440 660 1,060 3,500 15,000 400 1,100 440 660 1,060 1,060 922 0 1,060 802 0 1,060 697 0 1,060 606 0 1,060 527 0 1,060 458 3,500 15,000 400 1,100 440 660 1,060 -2,200 -2,200 3,260 1226 16 Table 6.4 Project Sensitivity to Sales Volume Sales Units 2000 3000 3604 4000 5000 6000 Net CF Operations 200000 550000 1003009 1300000 2050000 2800000 17 NPV Project 5005022 1884708 1235607 4355922 7476237 NPV v Discount Rate $7,000 $6,000 $5,000 NPV $000 $4,000 $3,000 $2,000 $1,000 $0 0% 5% 10% 15% 20% 25% 30% $1,000 $2,000 $3,000 Rate 18 35% 40% 45% 50% Sensitivity of Project to Sale Volume $3,000,000 Net CF from Operations $2,500,000 $2,000,000 $1,500,000 $1,000,000 $500,000 $0 $2,000 $2,500 $3,000 $3,500 $4,000 $4,500 $500,000 Sales (Units) 19 $5,000 $5,500 $6,000 NPV Project $10,000,000 $8,000,000 $6,000,000 NPV $4,000,000 $2,000,000 $0 2000 2500 3000 3500 4000 4500 $2,000,000 $4,000,000 $6,000,000 Sales (Units) 20 5000 5500 6000 Schedule of Bdella Price & Maint Age 10 Discount Price Maint Intang 20,000 16,000 1,000 12,800 1,000 800 10,240 1,100 8,192 1,210 -500 4,096 1,331 -600 2,048 1,464 -840 1,024 1,611 -1,176 512 1,772 -1,646 256 1,949 -2,305 128 2,144 -3,227 5.00% 21 Schedule of Bdella Price & Maint Age 10 Discount Price Maint Intang PV_Price PV_Maint PV_Intang PV_Proj 20,000 20,000 16,000 1,000 15,238 952 -3,810 12,800 1,000 800 11,610 907 726 -7,619 10,240 1,100 8,846 950 -11,334 8,192 1,210 -500 6,740 995 -411 -14,846 4,096 1,331 -600 3,209 1,043 -470 -19,890 2,048 1,464 -840 1,528 1,093 -627 -23,290 1,024 1,611 -1,176 728 1,145 -836 -26,071 512 1,772 -1,646 347 1,199 -1,114 -28,766 256 1,949 -2,305 165 1,256 -1,486 -31,689 128 2,144 -3,227 79 1,316 -1,981 -35,073 5.00% 22 Schedule of Bdella Price & Maint Age 10 Discount Price Maint Intang PV_Price PV_Maint PV_Intang PV_Proj Rate PV_Infinity Ann_Equ 20,000 20,000 16,000 1,000 15,238 952 -3,810 5.00% -80,000 -3,810 12,800 1,000 800 11,610 907 726 -7,619 10.25% -81,951 -3,902 10,240 1,100 8,846 950 -11,334 15.76% -83,236 -3,964 8,192 1,210 -500 6,740 995 -411 -14,846 21.55% -83,738 -3,988 4,096 1,331 -600 3,209 1,043 -470 -19,890 27.63% -91,881 -4,375 2,048 1,464 -840 1,528 1,093 -627 -23,290 34.01% -91,771 -4,370 1,024 1,611 -1,176 728 1,145 -836 -26,071 40.71% -90,112 -4,291 512 1,772 -1,646 347 1,199 -1,114 -28,766 47.75% -89,013 -4,239 256 1,949 -2,305 165 1,256 -1,486 -31,689 55.13% -89,167 -4,246 128 2,144 -3,227 79 1,316 -1,981 -35,073 62.89% -90,841 -4,326 5.00% 23 [...]... 20,000 20,000 20,000 3,500 15,000 400 1,100 440 660 1 ,060 3,500 15,000 400 1,100 440 660 1 ,060 3,500 15,000 400 1,100 440 660 1 ,060 3,500 15,000 400 1,100 440 660 1 ,060 3,500 15,000 400 1,100 440 660 1 ,060 3,500 15,000 400 1,100 440 660 1 ,060 0 1 ,060 922 0 0 1 ,060 802 0 0 1 ,060 697 0 0 1 ,060 606 0 0 1 ,060 527 0 0 1 ,060 458 3,500 15,000 400 1,100 440 660 1 ,060 -2,200 0 -2,200 3,260 1226 16 Table 6.4 Project... Price Growth Fixed Start Fixed Growth Variable pcent Depreciation schedule Start working capt Investment schedule Capital movements sch Dividend Working Cap Sch Year CF Forecast Sales revenue Expenses Fixed Costs (cash) Variable costs Depreciation Operating Profit Taxes Net Profit Operating CF Working cap move Investment in P&E Invest CF Net CF PV(NCF) (Table in $'000) 25.00% 40.00% $4,000 0.00% $5,000... Price Growth Fixed Start Fixed Growth Variable pcent Depreciation schedule Start working capt Investment schedule Capital movements sch Dividend Working Cap Sch Year CF Forecast Sales revenue Expenses Fixed Costs (cash) Variable costs Depreciation Operating Profit Taxes Net Profit Operating CF Working cap move Investment in P&E Invest CF Net CF PV(NCF) (Table in $'000) 15.00% 30.00% $4,000 0.00% $5,000... Price Growth Fixed Start Fixed Growth Variable pcent Depreciation schedule Start working capt Investment schedule Capital movements sch Dividend Working Cap Sch Year CF Forecast Sales revenue Expenses Fixed Costs (cash) Variable costs Depreciation Operating Profit Taxes Net Profit Operating CF Working cap move Investment in P&E Invest CF Net CF PV(NCF) (Table in $'000) 15.00% 40.00% $4,000 5.00% $5,000... Price Growth Fixed Start Fixed Growth Variable pcent Depreciation schedule Start working capt Investment schedule Capital movements sch Dividend Working Cap Sch Year CF Forecast Sales revenue Expenses Fixed Costs (cash) Variable costs Depreciation Operating Profit Taxes Net Profit Operating CF Working cap move Investment in P&E Invest CF Net CF PV(NCF) (Table in $'000) 15.00% 40.00% $4,000 0.00% $5,000... Price Growth Fixed Start Fixed Growth Variable pcent Depreciation schedule Start working capt Investment schedule Capital movements sch Dividend Working Cap Sch Year CF Forecast Sales revenue Expenses Fixed Costs (cash) Variable costs Depreciation Operating Profit Taxes Net Profit Operating CF Working cap move Investment in P&E Invest CF Net CF PV(NCF) (Table in $'000) 15.00% 40.00% $4,000 0.00% $5,000... Price Growth Fixed Start Fixed Growth Variable pcent Depreciation schedule Start working capt Investment schedule Capital movements sch Dividend Working Cap Sch Year CF Forecast Sales revenue Expenses Fixed Costs (cash) Variable costs Depreciation Operating Profit Taxes Net Profit Operating CF Working cap move Investment in P&E Invest CF Net CF PV(NCF) (Table in $'000) 15.00% 40.00% $4,000 2.00% $5,000