CapitalBudgeting (1) (1)
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University of South Florida, Tampa *
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Course
4323
Subject
Finance
Date
Feb 20, 2024
Type
xlsx
Pages
23
Uploaded by DoctorGalaxyWildcat25
Outline:
1. Simple Capital Budgeting
2. Ranking Projects with NPV and IRR
3. Issues with IRR
4. Capital Budgeting for personal investment
5. Lease or buy 6. Capital Budgeting with different life spans
7. Midyear discounting
8. Pro Forma Financial Statements and DCF Valuati
ion
$172.13 Discount rate
15%
2%
4%
6%
Year
Cash Flow
8%
0
$ (1,000.00)
10%
1
$ 100.00 12%
2
$ 200.00 14%
3
$ 300.00 16%
4
$ 400.00 18%
5
$ 500.00 20%
6
$ 600.00 22%
24%
NPV
$172.13 Accept
26%
IRR
19.71% Accept
28%
30%
Consider a project. The initial cash outflow, which represents the cost of the
remainning cash flows for years 1-6 are projected future cash flows. The dis
-What's NPV and IRR? Do they give you the same answer?
-Create a NPV profile, which is a chart showing the values of NPV given diff
0%
5%
$0.00 $2.00 $4.00 $6.00 $8.00 $10.00 $12.00 NPV
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e project today, is $1,000. The scount rate is 15%.
fferent discount rates.
%
10%
15%
20%
25%
30%
35%
NPV Profile
Discount Rates
Disc Rates NPV A
NPV B
2% $ 382.57 $ 311.53 Discount rate
8%
4% $ 321.69 $ 275.90 6% $ 266.60 $ 242.84 8% $ 216.64 $ 212.11 Year
Project A
Project B
Incremental CF
10% $ 171.22 $ 183.49 0
$ (500.00) $ (500.00)
$ - 12% $ 129.85 $ 156.79 1
$ 100.00 $ 250.00 $ (150.00)
14% $ 92.08 $ 131.84 2
$ 100.00 $ 250.00 $ (150.00)
16% $ 57.53 $ 108.47 3
$ 150.00 $ 200.00 $ (50.00)
18% $ 25.86 $ 86.57 4
$ 200.00 $ 100.00 $ 100.00 20%
$ (3.22) $ 66.00 5
$ 400.00 $ 50.00 $ 350.00 22%
$ (29.96) $ 46.66 24%
$ (54.61) $ 28.45 26%
$ (77.36) $ 11.28 NPV
$ 216.64 $ 212.11 A
28%
$ (98.39)
$ (4.93)
IRR
19.77%
27.38% B
30% $(117.87)
$ (20.25)
Crossover Point: The IRR That Makes Incremental NPV=0
IRR
8.51%
Consider mutually exclusive projects A and B, meaning you can only inve
projects have the same initial cost of $500 but have different future cash
relevant discount rate is 15%.
-What are NPVs and IRRs for both projects? Do they give you the same a
-What if the discount rate is 8%? Do they give you the same answer?
-Build a table and graph that show the NPV for each project as a function
-Calculate the Crossover Point, which is the discount rate at which the N
are equal.
est in one. Both h flow patterns. The answer?
n of the discount rate.
NPVs of the two projects 0%
5%
10%
15%
20%
25%
30%
35%
$(200.00)
$(100.00)
$- $100.00 $200.00 $300.00 $400.00 $500.00 NPV Profile for Mutually Exclusive Proj
NPV A
NPV B
Discount Rates
NPV
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Year
CFs
0 $ (800,000.00)
2%
($10,900.29)
1 $ 450,000.00 4%
$17,848.26 2 $ 450,000.00 6%
$38,122.89 3 $ 450,000.00 8%
$51,465.08 4 $ 450,000.00 10%
$59,143.15 5 $ 450,000.00 12%
$62,202.61 6 $ (1,500,000.00)
14%
$61,506.61 16%
$57,768.76 IRR
2.68%
18%
$51,579.65 IRR 2
27.74%
20%
$43,428.50 22%
$33,720.78 24%
$22,792.66 26%
$10,922.82 28%
($1,657.79)
30%
($14,757.93)
A company operates sanitary landfills. Here are the cash flows anticipat
The initial cost of the landfill is $800,000. This covers the expense of dig
appropriate truck access.
The annual net cash inflows from the landfill are $450,000. These repres
return for giving trash collection companies the right to dump their tras
of any costs incurred by the landfill company.
After five years the landfill will be full. The costs of closing the land fill, $1,500,000. This includes the costs of abiding by various ecological regu
-What's different about the cash flow patterns? What's the IRR of this co
-Create a NPV profile.
0%
5
($20,000.00)
($10,000.00)
$0.00 $10,000.00 $20,000.00 $30,000.00 $40,000.00 $50,000.00 $60,000.00 $70,000.00
ted by the company for a new landfill:
gging the hole, fencing it, and providing sent the fees the company collects in sh in the landfill. THese cash flows are net incurred at the end of year 6, are ulations and so on.
ompany's investment? 5%
10%
15%
20%
25%
30%
35%
NPV Profile
Inputs
Year
0
1
Cost of TownHome
$ 220,000.00 Initial CF
$ (220,000.00)
Rental Income
$ 24,000.00 Revenue Income
$ 24,000.00 Rental Growth Rate
3%
Property Tax
$ 3,000.00 Property Tax
$ 3,000.00 Property Insurance
$ 2,000.00 Property Tax Growth Rate
3%
Misc Expense
$ 1,000.00 Property Insurance
$ 2,000.00 Depreciation $ 8,000.00 Misc expense
$ 1,000.00 Before Tax Income
$ 10,000.00 Depreciation(Year)
27.50 Tax
$ 2,400.00 Income Tax Rate
24%
After Tax Income
$ 7,600.00 Resell Value
$ 500,000.00 OCF
$ 15,600.00 Capital gain tax
15%
Terminal CF
Required return
12%
Total CF
$ (220,000.00) $ 15,600.00 NPV
$22,166.28 Steps to calculate terminal cash flow
IRR
13.38%
1.Remaining BV = Initial Cost - accuulated depreciatiton
2.IF MV > BV, capita gain. Pay Tax = capital gain tax rate * gain
3.Terminal CF = MV - capital gain tax
2. IF MV < BV, capital loss. Receive tax benefit = capital gain tax rate * loss
3.Terminal Cf = MV + tax benefit
Remaining BV
$ 140,000.00 Capital Gain Tax
$ 54,000.00 Yuting is considering buying a unit of townhome in Clearw
planning to buy it with all cash. Here are some additional
Yuting figures she can rent out the townhome for $24000 property taxes of $3000 and property insurance of $2000 well, since real estate generally appreciates. And she is fig
All the income from the townhouse has to be reported on rate will continue for the foreseeable future. Her accountant has explained to her that she can depreci
At the end of year 10 she plans to resell the townhome for
the income.
-Calculate the cash flow for this investment each year. If s
-Conduct a sensitivity analysis (a two-input data table) to not profitable.
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Year
0
Inputs
Initial CF
$ (220,000.00)
Cost of Townhome
$ 220,000.00 Revenue Income
Rent
$ 24,000.00 Property Tax
Rent Growth
3%
Property Insurance
Property Tax
$ 3,000.00 Misc Expense
Propery Tax Growth
3%
Depreciation Insurance
$ 2,000.00 Before Tax Income
Misc Exp
$ 1,000.00 Tax
Income Tax Rate
24%
After Tax Income
Depreciation(Straight Line)
27.50 OCF
Resell Value
$ 500,000.00 Terminal CF
Capital Gains Tax Rate
15%
Total CF
$ (220,000.00)
Required Return
12%
NPV
$ 22,166.28 IRR
13.38%
13.38%
250000
280000
310000
340000
370000
400000
430000
460000
490000
520000
550000
2
3
4
5
6
7
8
$ 24,720.00 $ 25,461.60 $ 26,225.45 $ 27,012.21 $ 27,822.58 $ 28,657.26 $ 29,516.97 $ 3,090.00 $ 3,182.70 $ 3,278.18 $ 3,376.53 $ 3,477.82 $ 3,582.16 $ 3,689.62 $ 2,000.00 $ 2,000.00 $ 2,000.00 $ 2,000.00 $ 2,000.00 $ 2,000.00 $ 2,000.00 $ 1,000.00 $ 1,000.00 $ 1,000.00 $ 1,000.00 $ 1,000.00 $ 1,000.00 $ 1,000.00 $ 8,000.00 $ 8,000.00 $ 8,000.00 $ 8,000.00 $ 8,000.00 $ 8,000.00 $ 8,000.00 $ 10,630.00 $ 11,278.90 $ 11,947.27 $ 12,635.69 $ 13,344.76 $ 14,075.10 $ 14,827.35 $ 2,551.20 $ 2,706.94 $ 2,867.34 $ 3,032.56 $ 3,202.74 $ 3,378.02 $ 3,558.56 $ 8,078.80 $ 8,571.96 $ 9,079.92 $ 9,603.12 $ 10,142.01 $ 10,697.07 $ 11,268.79 $ 16,078.80 $ 16,571.96 $ 17,079.92 $ 17,603.12 $ 18,142.01 $ 18,697.07 $ 19,268.79 $ 16,078.80 $ 16,571.96 $ 17,079.92 $ 17,603.12 $ 18,142.01 $ 18,697.07 $ 19,268.79 water and renting it out for the income. The townhome will cost $220,000 an
facts:
a year, and the rent will grow by approximately 3% per year. She'll have to p
at the end of the year, and she assumes the property tax will grow at 3% per
guring on additional miscellaneous expenses of $1000 per year. their annual tax return. Currently, Yuting has a tax rate of 24%, and she thin
iate rental property based on MACRS 27.5 year straight-line depreciation sys
r $500,000. Since this is not her preminary residence, she will pay 15% capit
she requires 12% annual return, what are the NPV and IRR for this investme
show IRR as a function of resell value and rent. Highlight the combinations t
1
2
3
4
5
6
7
$ 24,000.00 $ 24,720.00 $ 25,461.60 $ 26,225.45 $ 27,012.21 $ 27,822.58 $ 28,657.26 $ 3,000.00 $ 3,090.00 $ 3,182.70 $ 3,278.18 $ 3,376.53 $ 3,477.82 $ 3,582.16 $ 2,000.00 $ 2,000.00 $ 2,000.00 $ 2,000.00 $ 2,000.00 $ 2,000.00 $ 2,000.00 $ 1,000.00 $ 1,000.00 $ 1,000.00 $ 1,000.00 $ 1,000.00 $ 1,000.00 $ 1,000.00 $ 8,000.00 $ 8,000.00 $ 8,000.00 $ 8,000.00 $ 8,000.00 $ 8,000.00 $ 8,000.00 $ 10,000.00 $ 10,630.00 $ 11,278.90 $ 11,947.27 $ 12,635.69 $ 13,344.76 $ 14,075.10 $ 2,400.00 $ 2,551.20 $ 2,706.94 $ 2,867.34 $ 3,032.56 $ 3,202.74 $ 3,378.02 $ 7,600.00 $ 8,078.80 $ 8,571.96 $ 9,079.92 $ 9,603.12 $ 10,142.01 $ 10,697.07 $ 15,600.00 $ 16,078.80 $ 16,571.96 $ 17,079.92 $ 17,603.12 $ 18,142.01 $ 18,697.07 $ 15,600.00 $ 16,078.80 $ 16,571.96 $ 17,079.92 $ 17,603.12 $ 18,142.01 $ 18,697.07 Accept
Accept
16000
18000
20000
22000
24000
26000
28000
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9
10
$ 30,402.48 $ 31,314.56 $ 3,800.31 $ 3,914.32 $ 2,000.00 $ 2,000.00 $ 1,000.00 $ 1,000.00 $ 8,000.00 $ 8,000.00 $ 15,602.17 $ 16,400.24 $ 3,744.52 $ 3,936.06 $ 11,857.65 $ 12,464.18 $ 19,857.65 $ 20,464.18 $ 446,000.00 $ 19,857.65 $ 466,464.18 nd she is pay r year as nks her stem. tal gain on ent? that are
8
9
10
$ 29,516.97 $ 30,402.48 $ 31,314.56 $ 3,689.62 $ 3,800.31 $ 3,914.32 $ 2,000.00 $ 2,000.00 $ 2,000.00 $ 1,000.00 $ 1,000.00 $ 1,000.00 $ 8,000.00 $ 8,000.00 $ 8,000.00 $ 14,827.35 $ 15,602.17 $ 16,400.24 $ 3,558.56 $ 3,744.52 $ 3,936.06 $ 11,268.79 $ 11,857.65 $ 12,464.18 $ 19,268.79 $ 19,857.65 $ 20,464.18 $ 446,000.00 Book Value
140000
$ 54,000.00 $ 19,268.79 $ 19,857.65 $ 466,464.18 30000
Tax Rate
40%
Borrow Rate
15%
Cost of Computer $4,000 Lease
$1,500 Year
0
1
2
3
Option 1: Buy
cost of Computer
($4,000)
Depreciation tax shield
$533.33 $533.33 $533.33 Total CF
($4,000)
$533 $533 $533 Option 2: Lease
Lease
($1,500)
($1,500)
($1,500)
($1,500)
Total CF
($900)
($900)
($900)
($900)
Incramental Cf
$3,100 ($1,433)
($1,433)
($1,433)
Leasing Option saves you $1300 today but c
IRR
18.33%
It's equivilent to getting a $3100 loan form c
Alternative Cost
9.00%
computer shop is charging you 18% for this After tax borrowing cost of only 9%, so leasi
Your business has decided that it needs another compu
The business has a tax rate of 40% and can borrow from
You can buy the computer for $4000 and depreciate it o
years ($1333 per year). So this depreciation will save yo
taxes. You can lease the computer for $1500 per year, payable
means you’ll pay $1500 today and $1500 at the end of e
payment is an expense for tax purpose, so its net after-t
40%)*1500 = $900.
-Should the company lease or buy?
-If buying is a better option, then what's the maximum l
make leasing worthwhile?
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costs you $1433 more for the next 3years, compared to buying
computer shop, and payign $1433 for 3 years
loan
ing is not a good option. uter. Here are the facts:
m the bank at 15%.
on a straight-line basis over 3 ou 40%*1333=533 per year in e in advance for 4 years. This each of years 1,2,3. The lease tax cost to the firm is (1-
lease payment we'll pay to
Discount Rate
12%
Replacement Chain Meth
Year Truck A
Truck B Year Truck A
0
-100000
-250000
0
-100000
1
150000
300000
1
150000
2
150000
300000
2
150000
3
150000
300000
3
150000
4
150000
4
150000
5
150000
5
150000
6
150000
6
150000
NPV( Without ajustment)
$516,711.10 $470,549.38 $516,711.10 Suppose your company is considering buying one of tw
materials. The company is trying to decide between tw
Truck A is relatively cheap truck. It costs $100,000 an
an annual cash flow of $150,000.
Truck B is much more expensive. It costs $250,000 an
replaced. However, truck B is much more efficient and
produces a cash flow of $300,000.
-If your company's discount rate is 12%, which truck s
-How to make them comparable?
hod
Equivalent Annuity Cashflow Method
Truck B Raw NPV / Pv of $1 oconstant annuity
-250000
Truck A Truck B
300000
EAC
$125,677.43 $195,912.75 300000
Choose B
50000
300000
300000
300000
$ 805,477.14 Choose B
wo tank trucks to haul high-tech liquid wo alternatives:
nd has a 6-year life, during which it will produce nd has only a 3-year life, after which it has to be d during each of the 3 years of its life it should it choose?
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A company owner is thinking about spending $10,000 in order to pro
annual cash flow of $3,000 per year for the next 5 years. If the discou
is 15%, and the cash flows occur at year end, what's the NPV?
What if the $3,000 annual cash flow is actually received as $750 at th
each quarter. Then what's the NPV?
In a lot of capital budgeting cases, cash flows are likely to occur as a
throughtout the year rather than a single year-end or quarter-end ca
Is there a compromise?
oduce an unt rate he end of a stream ash flow.
Year
2017
Income statement
Sales
$ 10,000,000.00 Cost of goods sold
$ (5,000,000.00)
Depreciation
$ (1,000,000.00)
Interest payments on debt
$ (320,000.00)
Interest earned on cash and marketable securities
$ 64,000.00 Profit before tax
$ 3,744,000.00 Taxes (40%)
$ (1,497,600.00)
Profit after tax
$ 2,246,400.00 Dividends
$ (898,560.00)
Retained Earnings
$ 1,347,840.00 Balance sheet
Cash
$ 800,000.00 Current assets
$ 1,500,000.00 Fixed assets
Fixed assets at cost
$ 10,700,000.00 Accumulated Depreciation
$ (3,000,000.00)
Net fixed assets
$ 7,700,000.00 Total assets
$ 10,000,000.00 Current liabilities
$ 800,000.00 Debt
$ 3,200,000.00 Equity
Stock (paid-in capital)
$ 4,500,000.00 Accumulated retained earnings
$ 1,500,000.00 Total liabilities and equity
$ 10,000,000.00 Project five yea
dental equipme
sensitivity anal
Starting point i
Projection ass
-Cooper Dental
planning mode
-Current assets
-Current liabili
-Net fixed asse
-Annual deprec
year.
-Cost of goods -Interest rate o
-Interest earne
-Tax rate is 40%
-Dividends: The
-Debt: Cooper D
specifies that it
replaid, the com
-Stock: Compan
to repurchase s
-Cash: This item
always equals t
assets - net fixe
For DCF valuat
FCFs is 6%. Analysis:
-What's the firm
-What's the est
-If the current stock?
-Conduct a sen
-Another sensit
WACC.
-Conduct a sce
Optimistic: Sa
Pessimistic: S
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ars of financial statements for Cooper Dental, a company that manufactures and ent. Calculate FCFs and run a DCF analysis to estimate the equity value. Conduc
lysis in the end.
is Cooper Dental's current income statement and balance sheet for year-end 201
sumptions:
l's current level of sales is $10,000,000. Over the 5-year horizon of the financial el, the firm expects its sales to grow at a rate of 10% per year.
s will be 15% of annual firm sales.
ities will be 8% of annual firm sales.
ets are assumed to be 77% of annual sales.
ciation charge is 10% of average value of the fixed assets on the books during the
sold is assumed to be 50% of sales.
on debt is 10% of average value of debts.
ed on cash is 8% of the average balance of cash.
% of firm's profit before taxes.
e firm pays out 40% of its profits after taxes as dividends to shareholders.
Dental currently has debt of $3,200,000. The company's agreement with the ban
t will repay $800,000 of this debt in each of the next 4 years. Once the debt is fu
mpany intends to stay debt-free.
ny has 1 million shares outstanding and does not intend either to issue new stoc
stock over the 5-year model horizon. Stock item remains at 2016 level.
m is the plug
. The cash item is defined so that the left-hand side of the balance s
the right-hand side of the balance sheets: Cash = total liabilities and equity - cur
ed assets. tion, assume the WACC for Cooper Dental is 14% and the long-term growth rate m's value based on DCF valuation?
timated value per share for Cooper Dental? Using mid-year discounting?
market value of Cooper Dental share is $10, what's our recommendation for this
nsitivity analysis showing the value per share as a function of sales growth rate.
tivity analysis showing the value per share as a function of long-term FCF growth
enario analysis showing the value per share under optimistic/pessimistic scenario
ales growth 18%, COGS/sales 40%, WACC 12%, FCF growth 8%.
Sales growth 5%, COGS/sales 55%, WACC 16%, FCF growth 3%.
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sells ct a 17.
e nk ully ck or sheet rrent of s h and os.
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IRR
14%
14%
10%
6%
Year
Project B
Discounted cashflow
Discounted cashflow
0
-50,000
-$50,000.00
-$50,000.00
1
15,000
$13,636.36
$14,150.94
2
15,000
$12,396.69
$13,349.95
3
15,000
$11,269.72
$12,594.29
4
15,000
$10,245.20
$11,881.40
5
15,000
$9,313.82
$11,208.87
NPV
$6,861.80
$13,185.46
IRR
15%
15%
Rate
Project A
Project B
0%
1%
2%
3%
4%
5%
6%
7%
8%
9%
10%
11%
12%
13%
14%
15%
16%
17%
18%
19%
20%
21%
22%
23%
24%
25%
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Financial Accounting
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Required Question .1 please without plagiarism
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Capital Budgeting
Assume you are evaluating two mutually exclusive projects, the cash flows of which appear below and that your company uses a cost of capital of 13% to evaluate projects such as these.
Time
Project A Cash Flows
Project B Cash Flows
0
-$46,800
-$63,600
1
-21,600
20,400
2
43,200
20,400
3
43,200
20,400
4
43,200
20,400
5
-28,800
20,400
Under what conditions on the cost of capital should project B be preferred to project A?
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Calculating IRR Compute the internal rate of return for the cash flows of the following two projects:
Year Project A Project B
0 -$7,300 -$4,390
1 3, 940 2,170
2 3,450 2,210
3 2,480 1,730
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Capital Budgeting
Assume you are evaluating two mutually exclusive projects, the cash flows of which appear below and that your company uses a cost of capital of 13% to evaluate projects such as these.
Time
Project A Cash Flows
Project B Cash Flows
0
-$46,800
-$63,600
1
-21,600
20,400
2
43,200
20,400
3
43,200
20,400
4
43,200
20,400
5
-28,800
20,400
Sketch the NPV profile for projects A & B.
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