CAPITAL BUDGETING AND LEASING Chapter 4
Slide 2Investment The expansion of strong resources for a business Disinvestment is the withdrawal of tough resources from the business
Slide 3Investment Opportunities Maintenance and substitution of depreciable capital things Adoption of cost-lessening ventures Adoption of salary expanding speculations A mix of the above
Slide 4Investment Analysis STEPS IN INVESTMENT ANALYSIS: 1. Distinguish POTENTIALLY PROFITABLE INVESTMENT ALTERNATIVES 2. Gather RELEVANT DATA ON: CAPITAL OUTLAYS COSTS RETURNS 3. Utilize AN APPROPRIATE METHOD TO ANALYZE THE DATA. 4. Choose WHETHER TO ACCEPT OR REJECT THE INVESTMENT OR SELECT THE TOP RANKING AMONG MUTUALLY EXCLUSIVE PROJECTS.
Slide 5Capital Budgeting The way toward arranging uses on resources whose profits will reach out past one year.
Slide 6Weighted Average Cost of Capital There are two sorts of capital put resources into a business: Debt Capital Equity Capital What is the cost of obligation? What is the cost of value?
Slide 7Weighted Average Cost of Capital K c = w d K d + w e K e Where: K c is the weighted normal cost of capital w d is the extent of advantages financed with obligation K d is the cost of obligation capital w e is the extent of benefits financed with value K e is the cost of value capital
Slide 8Payback Method The payback technique gives the quantity of years important to recuperate the underlying speculation. Does not represent the planning of money streams.
Slide 9Payback Method P = I/E WHERE: P = PAYBACK PERIOD IN YEARS I= INITIAL INVESTMENT OUTLAY E = ANNUAL NET CASH RETURN
Slide 10Simple Rate of Return Expresses the normal yearly net pay as a rate of the sum contributed. This might be as far as the underlying capital cost or the normal sum contributed over the helpful existence of the venture.
Slide 11Simple Rate of Return SRR = Y/I Where : SRR = SIMPLE RATE OF RETURN Y = AVERAGE ANNUAL NET CASH RECEIPTS (DEPRECIATION TAKEN INTO ACCOUNT) I = INITIAL INVESTMENT OUTLAY
Slide 12Calculation of Annual Cash Receipts Y =(E – D) WHERE: Y = AVERAGE ANNUAL NET INCOME E = TOTAL EXPECTED ANNUAL CASH RECEIPTS D= TOTAL ANNUAL DEPRECIATION
Slide 13Net Present Value (NPV) With the NPV, the money streams of the speculation are marked down by a base worthy compound yearly rate of return. The speculation is judged to be adequate if the present estimation of the money inflows surpasses the venture's available estimation of the money outpourings.
Slide 14Net Present Value (NPV) NPV = Σ PV Cash Inflows – Σ PV Cash Outflows
Slide 15Benefit Cost Ratio A proportion that uses a similar two components of the Net Present Value. B/C = Σ PV money inflows/Σ PV money surges
Slide 16Internal Rate of Return (IRR) The IRR is the accumulated dividends rate that compares the present estimation without bounds net money inflows with the money outpourings. On the other hand as it were the markdown rate that gives a NPV = Zero. Both the NPV and IRR consider the time estimation of cash. The reason for these venture investigation methods is to assess the worthiness of speculations in respect to an adequate rate of return.
Slide 17What goes into the Discount Rate? The markdown rate ought to mirror the cost of capital or the cost of assets used to fund the business. A venture is not adequate unless it produces an arrival adequate to take care of the expense of assets.
Slide 18What goes into the Discount Rate? The markdown rate contains three parts: Real Risk-Free Rate Risk Premium Inflation Expectations
Slide 19Other Considerations Regarding Capital Budgeting Profitability Index Used to designate constrained capital among a few autonomous activities. Show estimation of the money inflows separated by the money surges.
Slide 20Other Considerations Regarding Capital Budgeting Annuity Equivalent Used to contrast NPVs and unequal lives.
Slide 21Other Considerations Regarding Capital Budgeting Financial Feasibility Once you have assessed a venture, the financing of the venture ought to be resolved. After-duty money streams may not be adequate to meet obligation reimbursement necessities.
Slide 22Comparing Four Methods Among Three Investments
Slide 23Cash Flows for Three Investments
Slide 24Payback Method A 20000/6000 = 3.33 YEARS B 20000/5800 = 3.45 YEARS C 20000/5600 = 3.57 YEARS
Slide 25Simple Rate of Return A (30000-20000)/5 = 2000/20000 = 0.10 10% B (29000-20000)/5 = 1800/20000 = 0.09 9% C (28000-20000)/5 = 1600/20000 = 0.08 8%
Slide 26Net Present Value A NPV = - 20000 + 2000/(1.08) + 4000/(1.08) 2 + 6000/(1.08) 3 + 8000/(1.08) 4 + 10000/(1.08) 5 + 0/(1.08) 5 NPV = - 20000 + 1852 + 3429 + 4763 + 5880 + 6806 + 0 NPV = 2730
Slide 27Net Present Value and Internal Rate of Return A NPV = 2730 IRR = 12.01 B NPV = 3158 IRR = 13.82 C NPV = 3766 IRR = 17.57
Slide 28Leasing Versus Owning
Slide 29Leasing Versus Owning A rent speaks to an assention that gives control over an advantage claimed by the lessor to the resident for a particular timeframe upon the installment of a settled upon sum, known as lease.
Slide 30Types of Leases IN NON-REAL ESTATE LEASING THERE ARE SEVERAL TYPES OF LEASES: OPERATING LEASE CAPITAL (OR FINANCIAL) LEASE CUSTOM HIRE
Slide 31Operating Lease USUALLY A SHORT-TERM RENTAL ARRANGEMENT IN WHICH THE RENTAL CHARGE IS CALCULATED ON A TIME BASIS. For example, THE HOUR OR THE DAY, ETC. THE LESSEE PAYS THE DIRECT COST SUCH AS FUEL AND LABOR.
Slide 32Capital or Financial Lease A LONG - TERM CONTRACTUAL ARRANGEMENT IN WHICH THE LESSEE ACQUIRES CONTROL OF AN ASSET IN RETURN FOR RENTAL PAYMENTS. Generally RUNS FOR SEVEAL YEARS AND CANNOT BE Canceled WITHOUT PENALTY. IS FULLY AMORTIZED, MEANING THAT THE PRESENT VALUE OF THE LEASE PAYMENTS EQUALS THE FULL PRICE OF THE LEASED EQUIPMENT. MAY HAVE A PRUCHASE OPTION AT THE END OF THE LEASE.
Slide 33Capital Vs. Working Lease Capital rent exchanges a portion of the dangers of proprietorship to the renter.
Slide 34Issues in Capital Leasing Advantages: CONSERVATION OF WORKING CAPITAL NEARLY 100% FINANCING THE USE OF MODERN EQUIPMENT POSSIBLE TAX BENEFITS
Slide 35Evaluation of a rent versus Buy May be assessed by taking a gander at the present estimation of money streams for every choice.
Slide 36Sample Problem $ 30,000 TRUCK 35% TAX BRACKET 12% COST OF CAPITAL PURCHASE 30% DOWN PAYMENT LEVEL PAYMENTS 10% INTEREST 5 YEARS LEASE 5 YEAR LEASE ANNUAL PAYMENTS OF $7,000
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