Profitability Metrics, Payback Period Emily Riederer Instructor - PowerPoint PPT Presentation

DataCamp Financial Analytics in R FINANCIAL ANALYTICS IN R Profitability Metrics, Payback Period Emily Riederer Instructor

DataCamp Financial Analytics in R Profitability Metrics & Decision Rules Key Concepts: Profitability Metrics : quantify how and when a project contributes value to a firm Decision Rules : interpret metrics for decisions & comparisons Interpretation affected by: Absolute ($) versus relative (%) value Constrained versus unconstrained decision-making

DataCamp Financial Analytics in R Caveats of Decision Rules All of shortcomings; look at multiple dimensions Called "rules" but not the law! Don't take into account all aspects of strategy

DataCamp Financial Analytics in R Payback Period Definition : Time it takes to recoup initial investment Decision Rule : Shorter payback period is preferable - especially when low on cash! Pitfalls : Doesn't consider time-value of money Doesn't consider actual profit

DataCamp Financial Analytics in R Calculating Payback Period cashflows <- c(-10000, 2500, 3000, 5000, 6000, 1000) cumsum(cashflows) + init_investment n cashflow cumsum(cashflow) 0 -10000 -10000 1 2500 -7500 2 3000 -4500 3 5000 500 4 6000 6500 5 1000 7500

DataCamp Financial Analytics in R FINANCIAL ANALYTICS IN R Let's practice!

DataCamp Financial Analytics in R FINANCIAL ANALYTICS IN R NPV, IRR, and Profitability Index Emily Riederer Instructor

DataCamp Financial Analytics in R Net Present Value (NPV) Definition : Sum of all discounted cashflows minus (net) the cost of investment Decision Rule : Invest when NPV > 0 Generally prefer projects offering higher NPV Pitfalls : Highly sensitive to the discount rate Ignores project size

DataCamp Financial Analytics in R Calculating NPV n <- 0:(length(cashflows) - 1) npv <- sum( calc_pv(cashflows, r, n) ) npv

DataCamp Financial Analytics in R Internal Rate of Return (IRR) Definition : The required rate of return (i.e. discount rate) for the investment to break-even. Also known as the hurdle rate . Decision Rule : Invest when IRR > Discount Rate Generally prefer projects offering higher IRR Pitfalls : Doesn't capture magnitude of opportunity Could have zero or multiple IRRs Assumes 100% reinvestment of all cashflows at same rate

DataCamp Financial Analytics in R Calculating IRR # assume we have calc_npv function with signature: # calc_npv(cashflows, r) uniroot(calc_npv, interval = c(0, 1), cashflows = cashflows)$root

DataCamp Financial Analytics in R Profitability Index Definition : The ratio of the discounted value of all future cashflows divided by the cost of the initial investment Decision Rule : Profitable when profitability index > 1 Generally prefer projects offering higher profitability index Pitfalls : Like IRR, doesn't capture magnitude of opportunity Like NPV, highly reliant on estimated discount rate

DataCamp Financial Analytics in R Calculating Profitability Index npv_fcf <- calc_npv(future_cashflow, r) profitability_index <- npv_fcf / abs(initial_investment)

DataCamp Financial Analytics in R FINANCIAL ANALYTICS IN R Let's practice!

DataCamp Financial Analytics in R FINANCIAL ANALYTICS IN R Terminal Value Emily Riederer Instructor

DataCamp Financial Analytics in R What is terminal value (TV)? Represents all future cashflows past the end of our forecasting period Hard to measure with great granularity Improper to ignore

DataCamp Financial Analytics in R Adding terminal value to the cashflow

DataCamp Financial Analytics in R Calculating terminal value (TV) Perpetuity method : Assume constant growth rate of cashflow forever Growth rate must be less than discount rate Effect of growth muted by discounting over time final_cashflow <- cashflow[n] terminal_value_period_n <- final_cashflow / (discount_rate - growth_rate) terminal_value_as_present <- terminal_value_period_n / (1 + discount_rate)^n

DataCamp Financial Analytics in R Other approaches Exit multiplier method Use benchmark/factor on some key performance metric (e.g sales) Highly dependent on available data

DataCamp Financial Analytics in R FINANCIAL ANALYTICS IN R Let's give it a try!

DataCamp Financial Analytics in R FINANCIAL ANALYTICS IN R Comparing & Computing Metrics Emily Riederer Instructor

DataCamp Financial Analytics in R NPV vs. IRR Equal in unconstrained setting because NPV = 0 <-> IRR = Discount Rate IRR : Discount rate that allows us to break even NPV = 0 : Definition of breaking even

DataCamp Financial Analytics in R NPV vs IRR Equal in unconstrained setting because NPV = 0 <-> IRR = Discount Rate IRR : Discount rate that allows us to break even NPV = 0 : Definition of breaking even Not equal when we have to choose between options NPV answers in $ and size output depends on size input IRR answers in % and lacks context on opportunity size

DataCamp Financial Analytics in R Scoring Profitability Metrics with group_by() and summarize() options option time cashflow 1 0 -100 1 1 50 1 2 200 2 0 -300 2 1 60 2 2 500

DataCamp Financial Analytics in R Scoring Profitability Metrics with group_by() and summarize() options options %>% group_by(option) %>% summarize(npv=calc_npv(cf,0.08)) option time cf option npv 1 0 -100 1 118 1 1 50 2 184 1 2 200 2 0 -300 2 1 60 2 2 500

DataCamp Financial Analytics in R FINANCIAL ANALYTICS IN R Let's practice!

DataCamp Financial Analytics in R FINANCIAL ANALYTICS IN R Recap of Metrics Emily Riederer Instructor

DataCamp Financial Analytics in R Metrics Covered Concepts: Functions: Payback Period calc_payback() Net Present Value (NPV) calc_npv() Internal Rate of Return (IRR) calc_irr() Profitability Index calc_profitability_index()

DataCamp Financial Analytics in R Other Metrics Common Metrics ROE ROA Company Specific

DataCamp Financial Analytics in R FINANCIAL ANALYTICS IN R Onto the final chapter!