BUSINESS FINANCE/

FINANCIAL MARKETS & INSTITUTIONS

[B Sc (Hons) in Management]

SEMINAR 1

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TIME VALUE OF MONEY

Single Sum Annuity

Present Value

Future Value
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CAPITAL BUDGETING

Investment Decisions involving :

a) Large expenditures
b) Long term decisions

Can be in the form of :

a) Projects
b) Fixed assets
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CAPITAL BUDGETING :
INVESTMENT CRITERIA
Investment Formula Acceptance Time Arbitrary
Appraisal Criteria Value of Choice of
Technique Money Criteria
NPV NPV > 0

IRR IRR > Cost of

Capital

Profitability PI > 1
Index

Payback PP < cut off

Period period

Discounted DPP < cut off

PP period

ARCE ARCE >

required
return
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CAPITAL BUDGETING :
INVESTMENT CRITERIA (IRR)

1. Mutually Exclusive Projects

• Projects that cannot be taken up at the same time
• NPV & IRR may be consistent in recommending
whether to accept or reject each of them
• However, it may give different result as to which of
the project should be preferred due mainly to :
• Scale
• Duration
• How to Decide?
• NPV vs IRR
• Incremental CF approach
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CAPITAL BUDGETING :
INVESTMENT CRITERIA (IRR)
1. Multiple IRR
• Usually when there is double or more changes in
the signs of CFs
• May happen under 2 scenarios :
• Environmental sensitive project
• Long life public sector
2. Borrowing
• If the cash flows represents borrowing, then IRR
represents the cost of loan, not return on
investment
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CAPITAL BUDGETING :
CASH FLOW ESTIMATION

1. Important Steps in Capital Budgeting

Using the NPV Approach :
• Forecast the project cash flows
• Estimate the opportunity cost of capital
• Derive the NPV of the project by discounting the
cash flows using the opportunity cost of capital
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CAPITAL BUDGETING :
CASH FLOW ESTIMATION
1. Forecasting Cash Flows

a) Relevant CF

b) CF vs Profits

c) Non-Cash Expense

d) Fixed vs Variable Cash Flows

e) Working Capital
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CAPITAL BUDGETING :
CASH FLOW ESTIMATION
1. Forecasting Cash Flows

a) Indirect Effects

b) Sunk Costs

c) Opportunity Costs

d) Taxation (Depreciation & Salvage Value)

e) Nominal vs Real Cash Flows

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CAPITAL BUDGETING :
CASH FLOW ESTIMATION
Example :
A firm is considering an investment in a new manufacturing
plant. The site already is owned by the company, but
existing buildings would need to be demolished. Which of
the following should be treated as incremental cash flows?
a) The market value of the site
b) The market value of the existing buildings
c) Demolition costs and site clearance
d) The cost of a new access road put in last year
e) Lost cash flows on other projects due to executive time
spent on the new facility
f) Future depreciation of the new plant