CAPITAL BUDGETING AND LEASING

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Speculation. The expansion of strong advantages for a businessDisinvestment is the withdrawal of solid resources from the business. Speculation Opportunities. Upkeep and substitution of depreciable capital itemsAdoption of expense decreasing investmentsAdoption of pay expanding investmentsA mix of the above.

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CAPITAL BUDGETING AND LEASING Chapter 4

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Investment The expansion of strong resources for a business Disinvestment is the withdrawal of tough resources from the business

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Investment Opportunities Maintenance and substitution of depreciable capital things Adoption of cost-lessening ventures Adoption of salary expanding speculations A mix of the above

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Investment 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.

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Capital Budgeting The way toward arranging uses on resources whose profits will reach out past one year.

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Weighted 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?

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Weighted 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

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Payback Method The payback technique gives the quantity of years important to recuperate the underlying speculation. Does not represent the planning of money streams.

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Payback Method P = I/E WHERE: P = PAYBACK PERIOD IN YEARS I= INITIAL INVESTMENT OUTLAY E = ANNUAL NET CASH RETURN

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Simple 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.

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Simple 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

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Calculation of Annual Cash Receipts Y =(E – D) WHERE: Y = AVERAGE ANNUAL NET INCOME E = TOTAL EXPECTED ANNUAL CASH RECEIPTS D= TOTAL ANNUAL DEPRECIATION

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Net 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.

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Net Present Value (NPV) NPV = Σ PV Cash Inflows – Σ PV Cash Outflows

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Benefit 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

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Internal 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.

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What 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.

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What goes into the Discount Rate? The markdown rate contains three parts: Real Risk-Free Rate Risk Premium Inflation Expectations

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Other 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.

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Other Considerations Regarding Capital Budgeting Annuity Equivalent Used to contrast NPVs and unequal lives.

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Other 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.

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Comparing Four Methods Among Three Investments

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Cash Flows for Three Investments

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Payback Method A 20000/6000 = 3.33 YEARS B 20000/5800 = 3.45 YEARS C 20000/5600 = 3.57 YEARS

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Simple 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%

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Net 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

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Net 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

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Leasing Versus Owning

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Leasing 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.

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Types of Leases IN NON-REAL ESTATE LEASING THERE ARE SEVERAL TYPES OF LEASES: OPERATING LEASE CAPITAL (OR FINANCIAL) LEASE CUSTOM HIRE

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Operating 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.

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Capital 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.

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Capital Vs. Working Lease Capital rent exchanges a portion of the dangers of proprietorship to the renter.

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Issues in Capital Leasing Advantages: CONSERVATION OF WORKING CAPITAL NEARLY 100% FINANCING THE USE OF MODERN EQUIPMENT POSSIBLE TAX BENEFITS

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Evaluation of a rent versus Buy May be assessed by taking a gander at the present estimation of money streams for every choice.

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Sample 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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