-company is trying to figure out if they should make an investment decision

-investments cost money, so no wasting shareholders money

TECHNIQUES

-Payback period shorter the better (whats too long? ) once its paid back you stop, it ignores all cash flows beyond the payback period. Doesn’t take into the time value of money.

-Discounted payback- you converted the nominal cash flows in each time period into their equivalent present value, you need the appropriate discount rate. Always LONGER. Shorter investments are better, but you need a benchmark to compare it too.

-Accounting rate of return- uses net profit or net income from the income statement, doesn’t use cash flows like the other two above. Not an omtimal capita budgeting technique.

-net present value- not the most popular but considered the best technique to make a decision. Cacluate the future cashflows less the …. 0 or above you accept, below you reject. If the project is cost only, you get a negative NPV, so you just pick the least negative NPV. Higher cashflows increase NPV. If cost of capital inc, it has a negative impact on the NPV. Size effect- big profitable numbers have big Npvs, vice versa. NPV tells you how much the stockholders wealth will change

-profitabilty index- original investment cost +NPV divided by original investment cost, zero NPV would equal 1, so you need this number to be greater than 1. NPV is better then this.

-internal rate of return- most popular, where the NPV equals 0 , what rate of return makes NPV = 0

-Modified internal rate of return- most popular

Decision

ACEEPT OF REJECT THE DECISION

Estimating cash flows

a.Revenue generating- never being paid back is not good here.

b. cost only- government can shut you down, youre not expecting make a profit..just minimize your cost

TIME 0 1 2 3 4 5

CASH FLOW -5 +2 +1 +3 -1 +2 you cant use IRR here short coming of IRR

-reinvesting yr 1 to 5 cash flows

revenue gen: high risk high discount risk

COST ONLY high risk low discount rate

NPV RISK DISCOUNT RATES: 9 and 11 %

A-6 HI

B-8 HI

C-12 LOW

estimating cash flows

initial investment t=0

Purchase price of asset instal costs freight + or - sale of old asset

+ or - tax implication from sale of the old asset (below how it works)

+working capital investment

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net income

Book value of asset $200 a loss if you sell for 150 a gain if you sell for more then 200 * how your gains are taxed (gain x tax rate) * if you have a loss you have a tax refund ( loss X tax rate) if you lose, you don’t have to pay taxes

Book Value= original cost- accumulated depreciation

Tax Depreciation Canada (CCRA) US (MACRS)

tax dep= % depreciation rate for