Slide 1 ___________________________________ 8.5 Ca pita l Budg e ting o Ca pita l Budg e ting ___________________________________ o Plan to spe nd big mone y on a pr oje c t tha t has POSIT IVE futur e ___________________________________ implic ations to the organiza tion o Sa mple pr ojec ts: o Upg rade fac tory e quipme nt ___________________________________ o Inc re ase fac tory c a pac ity o T a ke on a large spe c ial pr oje c t ___________________________________ o E quipme nt re plac e me nt o L e ase or buy ___________________________________ 2005 KD Ha the wa y-Dia l ___________________________________ Slide 2 ___________________________________ Ca pita l Budg e ting o Ca pita l Budg e ting fa lls into… ___________________________________ o Sc r e e ning de c ision o Propose d pr oje c t me e ts a re quir e me nt ___________________________________ o F or e xa mple a pre -de te rmine d ra te of re turn or pay ba c k pe r iod o Pr e fe r e nc e de c ision ___________________________________ o Se le c tion of one proje c t from a fie ld of two or more proje c ts o F or e xa mple de te rmining whic h ma ke ___________________________________ a nd mode l of de live ry truc k to purc ha se ___________________________________ 2005 KD Ha the wa y-Dia l ___________________________________ Slide 3 ___________________________________ Ca pita l Budg e ting o Ca pita l budg e t me thods ___________________________________ o Ne t pr e se nt value o Inte r nal r ate of r e tur n (se e T 8M6) ___________________________________ o Paybac k pe r iod (se e T 8M6) o Simple rate of r e turn (se e T 8M6) ___________________________________ ___________________________________ ___________________________________ 2005 KD Ha the wa y-Dia l ___________________________________
Slide 4 ___________________________________ Ne t Pre se nt Value Me thod o Use s disc ounte d c a sh flows ___________________________________ o Compa r e s disc ounte d c a sh inflows to disc ounte d c ash outflows ___________________________________ o Abbre viate d NPV If the NPV T he n the pr oje c t is… ___________________________________ Positive ………… Ac c e ptable as it pr o mise s a gr e ate r r e tur n than r e quir e d Ze r o……………. Ac c e ptable as the re tur n e quals ___________________________________ the r e quir e d r ate of re tur n Ne gative ……… Not ac c e ptable as the r e tur n DOE S NOT me e t the r e quir e d r ate ___________________________________ of r e tur n 2005 KD Ha the wa y-Dia l ___________________________________ Slide 5 ___________________________________ Ne t Pre se nt Value Me thod o T ypic a l c a sh inflows ___________________________________ o Inc re a se d r e ve nue s o Re duc e d c osts ___________________________________ o Working c apital re le ase o Salvage value o T ypic a l c a sh outflows ___________________________________ o Initial inve stme nt o Working c apital ___________________________________ o Mainte na nc e o Inc re a se d e xpe nse s ___________________________________ 2005 KD Ha the wa y-Dia l ___________________________________ Slide 6 ___________________________________ Ne t Pre se nt Value Me thod o E mphasis on c ash flow not net ___________________________________ inc ome o Assumptions ___________________________________ o Cash flows oc c ur a t the e nd of pe r iods o Cash flows g e ne rate d by the ___________________________________ inve stme nt is r e inve ste d at a rate of re turn e qua l to the disc ount ra te o Cost of c apital ___________________________________ o Orga nizations minimum rate of re turn or disc ount rate ___________________________________ 2005 KD Ha the wa y-Dia l ___________________________________
Slide 7 ___________________________________ Ne t Pre se nt Value te mpla te Use ful te mplate or g uide for c a lc ulating Ne t pre se nt va lue ___________________________________ Ite m Ye ars Amount of PV fa c tor PV of c a sh c ash flow flows ___________________________________ Ne t Pr e se nt Va lue this wa y ___________________________________ ___________________________________ ___________________________________ 2005 KD Ha the wa y-Dia l ___________________________________ Slide 8 ___________________________________ Ne t Pre se nt Value E xa mple 1 Pa r kways Inc . is c onside r ing the addition of a ne w pr oduc t line to the ir ___________________________________ produc t mix. T o do this the y ne e d to purc hase a new mac hine . T he mac hine will c ost $60,000 to purc hase ___________________________________ and will g e ne r ate $15,000 of r e ve nue s pe r ye ar for the ne xt 8 ye ar s. T he mac hine will c ost $1,000 pe r ye a r to ___________________________________ maintain a nd have a salvage va lue of $5,000 at the e nd of the 8 ye ars. Pa r kways Inc . will also ne e d to inve st $20,000 for inve ntorie s and othe r ___________________________________ wor king c apital ne e ds. Using the Ne t Pre se nt Value method should Pa r kways purc ha se the mac hine if its ___________________________________ c ost of c apital is 15% ? 2005 KD Ha the wa y-Dia l ___________________________________ Slide 9 ___________________________________ Ne t Pre se nt Value E xa mple Amount of 15% PV of c ash c ash flow flows ___________________________________ Ite m Ye ars PV fac tor Initial inve stme nt – ne w mac hine 0 ($60,000) 1.000 ($60,000) ___________________________________ Wor king Ca pital 0 ($20,000) 1.000 ($20,000) Inc re a se d R e ve nue 1- 8 $15,000 4.4873 67,310 1 R e nt 1- 8 ($1,000) 4.4873 2 (4,487) ___________________________________ Sa lva ge Value 8 $5,000 0.3269 1,635 3 Working Ca pital R e le a se 4 8 $20,000 0.3269 6,538 ___________________________________ NPV (9,004) Se e T 8M4 1 (1-(1/ (1.15) 8 ))/ .15 = 4.48733 1/ (1.15) 8 = 0.3269 for how to 3 c a lc ula te 4 1/ (1.15) 8 = 0.3269 2 (1-(1/ (1.15) 8 ))/ .15 = 4.48733 ___________________________________ PV fa c tors 2005 KD Ha the wa y-Dia l ___________________________________
Slide 10 ___________________________________ Ne t Pre se nt Value E xa mple Amount of 15% PV of c ash c ash flow flows ___________________________________ Ite m Ye ars PV fac tor Initial inve stme nt – ne w mac hine 0 ($60,000) 1.000 ($60,000) CT ___________________________________ Wor king Ca pital 0 ($20,000) 1.000 ($20,000) PROJE Inc re a se d R e ve nue 1- 8 $15,000 4.4873 67,310 1 R e nt 1- 8 ($1,000) 4.4873 2 (4,487) ___________________________________ CT Sa lva ge Value 8 $5,000 0.3269 1,635 3 JE Working Ca pital RE R e le a se 4 8 $20,000 0.3269 6,538 ___________________________________ NPV (9,004) Se e T 8M4 1 (1-1/ (1.15) 8 )/ .15 = 4.48733 1/ (1.15) 8 = 0.3269 for how to 3 c a lc ula te 4 1/ (1.15) 8 = 0.3269 2 (1-1/ (1.15) 8 )/ .15 = 4.48733 ___________________________________ PV fa c tors 2005 KD Ha the wa y-Dia l ___________________________________ Slide 11 ___________________________________ Ne t Pre se nt Value E xa mple 2 Jane Summe rs ha s just inhe rite d $600,000 fr om he r mothe r’s e state . She is c onside ring inve sting pa rt of these ___________________________________ funds in a small c a te ring busine ss. She would ne e d to purc hase a de live r y van and various e quipme nt c osting $100,000 to e quip the busine ss and anothe r $50,000 for ___________________________________ inve ntor ie s a nd other working c a pital ne eds. Re nt on the building use d by the busine ss will be $24,000 pe r yea r. Ja ne ’s ma rketing studie s indic ated tha t the a nnua l c a sh inflow from the busine ss will amount to $90,000. In a ddition ___________________________________ to the building re nt, othe r annua l c ash outflows for ope rating c osts will amount to $30,000. Jane wants to ope rate the c ate r ing busine ss for only six ye a r s. She e stimate s that the e quipme nt c ould be sold at that time ___________________________________ for a bout 10% of its orig inal c ost. Jane ’s require d rate of re tur n is 16% . ___________________________________ 2005 KD Ha the wa y-Dia l ___________________________________ Slide 12 ___________________________________ Ne t Pre se nt Value E xa mple 2 Ite m Ye ars Amount of 16% PV of c ash ___________________________________ c ash flow PV fac tor flows Initial Inve stme nt - e quipme nt 0 ($100,000) 1.000 ($100,000) ___________________________________ Wor king Ca pital 0 ($ 50,000) 1.000 ($ 50,000) R e nt 1- 6 ($ 24,000) 3.6847 ($ 88,434) Ca sh inflows 1- 6 $ 90,000 3.6847 $ 331,623 ___________________________________ Ca sh outflows 1- 6 ($ 30,000) 3.6847 ($110,541) Sa lva ge Value 6 $ 10,000 0.4104 4,104 Working Ca pital ___________________________________ R e le a se 6 $ 50,000 0.4104 $ 20,522 Ne t Pre se nt Va lue $ 7,274 ___________________________________ ACCE PT OR RE JE CT ? 2005 KD Ha the wa y-Dia l ___________________________________
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