Time value of money
grows over time
future value
annuity
same amount money received
every year for T years
start 1 year from now (first payment in 1 year from today)
present value
perpetuity
same amount money received
every year FOREVER
starting 1 year from now
capital investment
expenditure today = generate cash inflow tomorrow
cost < benefit
Investment appraisal techniques
- NPV
- IRR
- payback
- ARR
Payback
yrs to recover initial
target - less than and shortest
screening method
+ - imminent cf, simple, cf based
- time value, size/time of cf, outside period cf
NPV
discounted cf - cost of capita/ target rate of return - discount rate
-cost + sum of future cash inflows
+ primary obj, DCF model, time value, account all cf
- understand, estimate discount rate (not constant) , capital is scarce
primary objective
maximise SHs wealth
IRR
cost of capital/discount rate when applied = NPV of 0
IRR > target rate (higher is better), mkt rate < discount = +ve IRR
return rate < cost of borrowing = won’t do it
dont know the correct IRR
multiple IRR
non normal cash flows = more than 1 change in cf direction
project calls for large cash outflow during end of life
goal of a finance manager
maximise SH wealth
-select project that maximises firm value
-detailed analysis of project and aspects
-international = more factors to analyse
9 issues of international
- financing arragements
- risk adjustment
- foreign exchange
- remittance
- taxation
- project vs parent cash flow
- uncertain salvage value
- blocked funds
- inflation
multinational capital budgeting
- evaluate international projects
- NPV
- c.f in more than 1 currency
- subsidiary = manage daily
- parent = finances project
capital investment decision stages
- estimate expected cash flow
- cost of capital
- NPV
estimating cash flows
- estimate future
- incremental
- cash
(working capital)
inflow = +
outflow = -
parent view = max MNC value, cf remitted to parent = shows perf, determine financial viability
incremental cash flow
relevant, because// all incremental, non cash items not considered
1. sunk costs (exclude) - cant be recovered e.g cost of financial analysis
2. opportunity costs (include) - cash flow without the project, benefits forgone because of the project
3. externalities (include) - 2 product linked e.g. cannibalisation, new product add or take away from existing
whether to include
incremental cash flow
would the cash flow be influenced by the investment decision
YES - include in analysis
NO - dont include it
working capital
CHANGES to cash flow
CA - CL
decrease = inflow = money loosen from asset
increase = outflow = money tied up in asset
project cash flow
- initial inv
- operating rev & expense
- profit from subsidiary
- post tax profit
- remittance to parent
- parent may rely on dividend received to cover central expenses
sources of finance
- kd - before tax cost of debt
- ke - cost of equity
firms use both E & D to finance - weighted average cost of capital
cost of capital = discount rate = reflect risk and type of cf = increase cost of borrowing = increase risk = political and foreign exchange uncertainty
kd
interest firm pays to borrow from bank or bond market to fund project
before tax cost of debt
after tax = kd(1-t)
ke
cost of equity
return (expected) return on equity firm pays investors
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Finance Topic 1, 2, 353
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Business Forecasting Topic 118
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Business Forecasting Topic 222
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Business Forecasting Topic 326
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Business Forecasting Topic 422
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Business Forecasting Topic 529
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Business Forecasting Topic 624
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Business Forecasting Topic 728
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Business Forecasting Topic 821
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Business Forecasting Topic 910
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Business Forecasting Topic 1019
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Business Forecasting Topic 1118
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Consumer Psychology Topic 11
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MNE Topic 219
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MNE Topic 339
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MNE Topic 417
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MNE Topic 634
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MNE Topic 748
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MNE Topic 833
