1、13-113-2u Project Evaluation and Selectionu Potential Difficultiesu Capital Rationingu Project Monitoringu Post-Completion Audit13-3u Payback Period(PBP)u Internal Rate of Return(IRR)u Net Present Value(NPV)u Profitability Index(PI)13-4Julie Miller is evaluating a new project for her firm,Basket Won
2、ders(BW).She has determined that the after-tax cash flows for the project will be$10,000;$12,000;$15,000;$10,000;and$7,000,respectively,for each of the Years 1 through 5.The initial cash outlay will be$40,000.13-5-A project whose acceptance(or rejection)does not prevent the acceptance of other proje
3、cts under consideration.uFor this project,assume that it is independent of any other potential projects that Basket Wonders may undertake.13-6 is the period of time required for the cumulative expected cash flows from an investment project to equal the initial cash outflow.0 1 2 3 4 5 -40 K 10 K 12
4、K 15 K 10 K 7 K13-7(c)10 K 22 K 37 K 47 K 54 K=a+(b-c)/d=3+(40-37)/10=3+(3)/10=0 1 2 3 4 5 -40 K 10 K 12 K 15 K 10 K 7 KCumulativeInflows(a)(-b)(d)13-8=3+(3K)/10K=Note:Take absolute value of last negative cumulative cash flow value.CumulativeCash Flows -40 K 10 K 12 K 15 K 10 K 7 K0 1 2 3 4 5-40 K -
5、30 K -18 K -3 K 7 K 14 K13-9Yes!The firm will receive back the initial cash outlay in less than 3.5 years.3.3 Years 3.5 Year Max.The management of Basket Wonders has set a maximum PBP of 3.5 years for projects of this type.Should this project be accepted?13-10u Easy to use and understandu Can be use
6、d as a measure of liquidityu Easier to forecast ST than LT flowsu Does not account for TVMu Does not consider cash flows beyond the PBPu Cutoff period is subjective13-11IRR is the discount rate that equates the present value of the future net cash flows from an investment project with the projects i
7、nitial cash outflow.CF1 CF2 CFn(1+IRR)1 (1+IRR)2 (1+IRR)n+.+ICO=13-12$15,000$10,000$7,000$10,000$12,000(1+IRR)1 (1+IRR)2Find the interest rate(IRR)that causes the discounted cash flows to equal$40,000.+$40,000=(1+IRR)3 (1+IRR)4 (1+IRR)513-13=$10,000(PVIF10%,1)+$12,000(PVIF10%,2)+$15,000(PVIF10%,3)+$
8、10,000(PVIF10%,4)+$7,000(PVIF10%,5)=$10,000(.909)+$12,000(.826)+$15,000(.751)+$10,000(.683)+$7,000(.621)=$9,090+$9,912+$11,265+$6,830+$4,347 =13-14=$10,000(PVIF15%,1)+$12,000(PVIF15%,2)+$15,000(PVIF15%,3)+$10,000(PVIF15%,4)+$7,000(PVIF15%,5)=$10,000(.870)+$12,000(.756)+$15,000(.658)+$10,000(.572)+$7
9、,000(.497)=$8,700+$9,072+$9,870+$5,720+$3,479 =13-15.10$41,444.05IRR$40,000$4,603.15$36,841 X$1,444.05$4,603$1,444X=13-16.10$41,444.05IRR$40,000$4,603.15$36,841 X$1,444.05$4,603$1,444X=13-17.10$41,444.05IRR$40,000$4,603.15$36,841($1,444)(0.05)$4,603$1,444XX=X=.0157IRR=.10+.0157=.1157 or 11.57%13-18
10、No!The firm will receive 11.57%for each dollar invested in this project at a cost of 13%.IRR Hurdle Rate The management of Basket Wonders has determined that the hurdle rate is 13%for projects of this type.Should this project be accepted?13-19u Accounts for TVMu Considers all cash flowsu Less subjec
11、tivityu Assumes all cash flows reinvested at the IRRu Difficulties with project rankings and Multiple IRRs13-20 NPV is the present value of an investment projects net cash flows minus the projects initial cash outflow.CF1 CF2 CFn(1+k)1 (1+k)2 (1+k)n+.+-NPV=13-21Basket Wonders has determined that the
12、 appropriate discount rate(k)for this project is 13%.$10,000$7,000$10,000$12,000$15,000(1.13)1 (1.13)2 (1.13)3+-(1.13)4 (1.13)5=+13-22=$10,000(PVIF13%,1)+$12,000(PVIF13%,2)+$15,000(PVIF13%,3)+$10,000(PVIF13%,4)+$7,000(PVIF13%,5)-=$10,000(.885)+$12,000(.783)+$15,000(.693)+$10,000(.613)+$7,000(.543)-=
13、$8,850+$9,396+$10,395+$6,130+$3,801-=-13-23 No!The NPV is negative.This means that the project is reducing shareholder wealth.as The management of Basket Wonders has determined that the required rate is 13%for projects of this type.Should this project be accepted?13-24 u Cash flows assumed to be rei
14、nvested at the hurdle rate.u Accounts for TVM.u Considers all cash flows.u May not include managerial options embedded in the project.See Chapter 14.13-25Discount Rate(%)0 3 6 9 12 15IRRNPV13%Sum of CFsPlot NPV for eachdiscount rate.Three of these points are easy now!Net Present Value$000s151050-413
15、-26 PI is the ratio of the present value of a projects future net cash flows to the projects initial cash outflow.CF1 CF2 CFn(1+k)1 (1+k)2 (1+k)n+.+PI=PI=1+/13-27 No!The is less than 1.00.This means that the project is not profitable.as =$38,572/$40,000=.9643(Method#1,13-33)Should this project be ac
16、cepted?13-28Same as NPVu Allows comparison of different scale projectsSame as NPVu Provides only relative profitabilityu Potential Ranking Problems13-29Method Project Comparison Decision PBP 3.3 3.5 Accept IRR 11.47%13%Reject NPV-$1,424$0 Reject PI.96 1.00 Reject Basket Wonders Independent Project13
17、-30-A project whose acceptance precludes the acceptance of one or more alternative projects.-A project whose acceptance depends on the acceptance of one or more other projects.13-31 Ranking of project proposals may create contradictory results.13-32 Compare a small(S)and a large(L)project.NET CASH F
18、LOWSProject S Project LEND OF YEAR 0 -$100 -$100,000 1 0 0 2$400$156,25013-33Calculate the PBP,IRR,NPV10%,and PI10%.Which project is preferred?Why?Project IRR NPV PI S 100%$231 3.31 L 25%$29,132 1.2913-34Let us compare a decreasing cash-flow(D)project and an increasing cash-flow(I)project.NET CASH F
19、LOWSProject D Project IEND OF YEAR 0 -$1,200 -$1,200 1 1,000 100 2 500 600 3 100 1,08013-35 D 23%I 17%Calculate the IRR,NPV10%,and PI10%.Which project is preferred?Project IRR NPV PI13-36Discount Rate(%)0 5 10 15 20 25-200 0 200 400 600IRRNPV10%Plot NPV for eachproject at variousdiscount rates.Net P
20、resent Value($)13-37Discount Rate($)0 5 10 15 20 25-200 0 200 400 600Net Present Value($)13-38 Let us compare a long life(X)project and a short life(Y)project.NET CASH FLOWSProject X Project YEND OF YEAR 0 -$1,000 -$1,000 1 0 2,000 2 0 0 3 3,375 013-39 X 50%$1,536 2.54 Y 100%$818 1.82Calculate the P
21、BP,IRR,NPV10%,and PI10%.Which project is preferred?Why?Project IRR NPV PI13-401.Adjust cash flows to a common terminal year if project“Y”will be replaced.Compound Project Y,Year 1 10%for 2 years.Year 0 1 2 3CF -$1,000$0$0$2,420Results:IRR*=34.26%NPV=$818*Lower IRR from adjusted cash-flow stream.X is
22、 still Best.13-412.Use Replacement Chain Approach(Appendix B)when project“Y”will be replaced.0 1 2 3Results:IRR*=100%=*Higher NPV,but the same IRR.13-42Capital Rationing occurs when a constraint(or budget ceiling)is placed on the total size of capital expenditures during a particular period.Example:
23、Julie Miller must determine what investment opportunities to undertake for Basket Wonders(BW).She is limited to a maximum expenditure of$32,500 only for this capital budgeting period.13-43 Project ICO IRR NPV PIA$500 18%$50 1.10 B 5,000 25 6,500 2.30 C 5,000 37 5,500 2.10 D 7,500 20 5,000 1.67 E12,5
24、00 26 500 1.04 F15,000 28 21,000 2.40 G17,500 19 7,500 1.43 H25,000 15 6,000 1.2413-44 Project ICO IRR NPV PIC$5,00037%$5,500 2.10 F15,000 28 21,000 2.40 E12,50026 500 1.04 B 5,00025 6,500 2.30 Projects C,F,and E have the three largest IRRs.The resulting increase in shareholder wealth is$27,000 with
25、 a$32,500 outlay.13-45 Project ICO IRR NPV PI F$15,000 28%$21,000 2.40 G17,50019 7,500 1.43 B 5,00025 6,500 2.30Projects F and G have the two largest NPVs.The resulting increase in shareholder wealth is$28,500 with a$32,500 outlay.13-46 Project ICO IRR NPV PI F$15,000 28%$21,000 2.40B 5,000 25 6,500
26、 2.30 C 5,000 37 5,500 2.10 D 7,500 20 5,000 1.67 G 17,500 19 7,500 1.43Projects F,B,C,and D have the four largest PIs.The resulting increase in shareholder wealth is$38,000 with a$32,500 outlay.13-47 Method Projects Accepted Value Added PI F,B,C,and D$38,000 NPV F and G$28,500 IRRC,F,and E$27,000 g
27、enerates the in when a limited capital budget exists for a single period.13-48Post-completion AuditA formal comparison of the actual costs and benefits of a project with original estimates.u Identify any project weaknessesu Develop a possible set of corrective actionsu Provide appropriate feedbackRe
28、sult:Making better future decisions!13-49 There are as many potential IRRs as there are sign changes.Let us assume the following cash flow pattern for a project for Years 0 to 4:-$100 +$100 +$900 -$1,000*Refer to Appendix A13-50Discount Rate(%)0 40 80 120 160 200Net Present Value($000s)Multiple IRRs at=and 7550250-100
