Slide 1 ___________________________________ 8.5 Ca pita l Budg e - - PDF document

Slide 1

8.5 Ca pita l Budg e ting

2005 KD Ha the wa y-Dia l

• Ca pita l Budg e ting
• Plan to spe nd big mone y on a

pr

• je c t tha t has POSIT

IVE futur e implic ations to the organiza tion

• Sa mple pr
• jec ts:
• Upg rade fac tory e quipme nt
• Inc re ase fac tory c a pac ity
• T

a ke on a large spe c ial pr

• je c t
• E

quipme nt re plac e me nt

• L

e ase or buy

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Ca pita l Budg e ting

• Ca pita l Budg e ting fa lls into…
• Sc r

e e ning de c ision

• Propose d pr
• je c t me e ts a re quir

e me nt

• F
• r e xa mple a pre -de te rmine d ra te of

re turn or pay ba c k pe r iod

• Pr

e fe r e nc e de c ision

• Se le c tion of one proje c t from a fie ld of

two or more proje c ts

• F
• r e xa mple de te rmining whic h ma ke

a nd mode l of de live ry truc k to purc ha se

2005 KD Ha the wa y-Dia l

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Ca pita l Budg e ting

• Ca pita l budg e t me thods
• Ne t pr

e se nt value

• Inte r

nal r ate of r e tur n (se e T 8M6)

• Paybac k pe r

iod (se e T 8M6)

• Simple rate of r

e turn (se e T 8M6)

2005 KD Ha the wa y-Dia l

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Slide 4

Ne t Pre se nt Value Me thod

• Use s disc ounte d c a sh flows
• Compa r

e s disc ounte d c a sh inflows to disc ounte d c ash outflows

• Abbre viate d NPV

2005 KD Ha the wa y-Dia l

Not ac c e ptable as the r e tur n DOE S NOT me e t the r e quir e d r ate

• f r

e tur n Ne gative ……… Ac c e ptable as the re tur n e quals the r e quir e d r ate of re tur n Ze r

• …………….

Ac c e ptable as it pr

• mise s a

gr e ate r r e tur n than r e quir e d Positive ………… T he n the pr

• je c t is…

If the NPV

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Ne t Pre se nt Value Me thod

• T

ypic a l c a sh inflows

• Inc re a se d r

e ve nue s

• Re duc e d c osts
• Working c apital re le ase
• Salvage value
• T

ypic a l c a sh outflows

• Initial inve stme nt
• Working c apital
• Mainte na nc e
• Inc re a se d e xpe nse s

2005 KD Ha the wa y-Dia l

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Ne t Pre se nt Value Me thod

• E

mphasis on c ash flow not net inc ome

• Assumptions
• Cash flows oc c ur a t the e nd of

pe r iods

• Cash flows g e ne rate d by the

inve stme nt is r e inve ste d at a rate of re turn e qua l to the disc ount ra te

• Cost of c apital
• Orga nizations minimum rate of re turn
• r disc ount rate

2005 KD Ha the wa y-Dia l

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Slide 7

Ne t Pre se nt Value te mpla te

2005 KD Ha the wa y-Dia l

PV of c a sh flows PV fa c tor Amount of c ash flow Ye ars Ite m

Use ful te mplate or g uide for c a lc ulating Ne t pre se nt va lue

Ne t Pr e se nt Va lue this wa y

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Ne t Pre se nt Value E xa mple 1

Pa r kways Inc . is c onside r ing the addition of a ne w pr

• duc t line to the ir

produc t mix. T

• do this the y ne e d to

purc hase a new mac hine . T he mac hine will c ost $60,000 to purc hase and will g e ne r ate $15,000 of r e ve nue s pe r ye ar for the ne xt 8 ye ar

• s. T

he mac hine will c ost $1,000 pe r ye a r to maintain a nd have a salvage va lue of $5,000 at the e nd of the 8 ye ars. Pa r kways Inc . will also ne e d to inve st $20,000 for inve ntorie s and othe r wor king c apital ne e ds. Using the Ne t Pre se nt Value method should Pa r kways purc ha se the mac hine if its c ost of c apital is 15% ?

2005 KD Ha the wa y-Dia l

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Ne t Pre se nt Value E xa mple

2005 KD Ha the wa y-Dia l

6,538 0.3269 $20,000 8 Working Ca pital R e le a se (4,487) 4.4873 ($1,000) 1- 8 R e nt 67,310 4.4873 $15,000 1- 8 Inc re a se d R e ve nue (9,004) NPV 1,635 0.3269 $5,000 8 Sa lva ge Value ($20,000) 1.000 ($20,000) Wor king Ca pital ($60,000) 1.000 ($60,000) Initial inve stme nt – ne w mac hine PV of c ash flows 15% PV fac tor Amount of c ash flow Ye ars Ite m 1 2 3 4 1 2 3 4 (1-(1/ (1.15)8))/ .15 = 4.48733 1/ (1.15)8 = 0.3269 1/ (1.15)8 = 0.3269 Se e T 8M4 for how to c a lc ula te PV fa c tors (1-(1/ (1.15)8))/ .15 = 4.48733

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Slide 10

Ne t Pre se nt Value E xa mple

2005 KD Ha the wa y-Dia l

6,538 0.3269 $20,000 8 Working Ca pital R e le a se (4,487) 4.4873 ($1,000) 1- 8 R e nt 67,310 4.4873 $15,000 1- 8 Inc re a se d R e ve nue (9,004) NPV 1,635 0.3269 $5,000 8 Sa lva ge Value ($20,000) 1.000 ($20,000) Wor king Ca pital ($60,000) 1.000 ($60,000) Initial inve stme nt – ne w mac hine PV of c ash flows 15% PV fac tor Amount of c ash flow Ye ars Ite m 1 2 3 4 1 2 3 4 (1-1/ (1.15)8)/ .15 = 4.48733 1/ (1.15)8 = 0.3269 1/ (1.15)8 = 0.3269 (1-1/ (1.15)8)/ .15 = 4.48733 Se e T 8M4 for how to c a lc ula te PV fa c tors

RE JE CT PROJE CT

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Ne t Pre se nt Value E xa mple 2

Jane Summe rs ha s just inhe rite d $600,000 fr

• m he r

mothe r’s e state . She is c onside ring inve sting pa rt of these funds in a small c a te ring busine ss. She would ne e d to purc hase a de live r y van and various e quipme nt c osting $100,000 to e quip the busine ss and anothe r $50,000 for inve ntor ie s a nd other working c a pital ne eds. Re nt on the building use d by the busine ss will be $24,000 pe r yea r. Ja ne ’s ma rketing studie s indic ated tha t the a nnua l c a sh inflow from the busine ss will amount to $90,000. In a ddition to the building re nt, othe r annua l c ash outflows for

• pe rating c osts will amount to $30,000. Jane wants to
• pe rate the c ate r

ing busine ss for

• nly six ye a r
• s. She

e stimate s that the e quipme nt c ould be sold at that time for a bout 10% of its orig inal c ost. Jane ’s require d rate of re tur n is 16% .

2005 KD Ha the wa y-Dia l

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Ne t Pre se nt Value E xa mple 2

2005 KD Ha the wa y-Dia l

$ 331,623 3.6847 $ 90,000 1- 6 Ca sh inflows ($ 88,434) 3.6847 ($ 24,000) 1- 6 R e nt 4,104 0.4104 $ 10,000 6 Sa lva ge Value ($110,541) 3.6847 ($ 30,000) 1- 6 Ca sh outflows $ 7,274 Ne t Pre se nt Va lue $ 20,522 0.4104 $ 50,000 6 Working Ca pital R e le a se ($ 50,000) 1.000 ($ 50,000) Wor king Ca pital ($100,000) 1.000 ($100,000) Initial Inve stme nt - e quipme nt PV of c ash flows 16% PV fac tor Amount of c ash flow Ye ars Ite m

ACCE PT OR RE JE CT ?

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Slide 13

Ne t Pre se nt Value E xa mple 2

2005 KD Ha the wa y-Dia l

$ 331,623 3.6847 $ 90,000 1- 6 Ca sh inflows ($ 88,434) 3.6847 ($ 24,000) 1- 6 R e nt 4,104 0.4104 $ 10,000 6 Sa lva ge Value ($110,541) 3.6847 ($ 30,000) 1- 6 Ca sh outflows $ 7,274 Ne t Pre se nt Va lue $ 20,522 0.4104 $ 50,000 6 Working Ca pital R e le a se ($ 50,000) 1.000 ($ 50,000) Wor king Ca pital ($100,000) 1.000 ($100,000) Initial Inve stme nt - e quipme nt PV of c ash flows 16% PV fac tor Amount of c ash flow Ye ars Ite m

ACCE PT OR RE JE CT ?

ACCE PT PROJE CT

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