The document discusses capital budgeting and investment project evaluation. It states that when projects deliver discounted cash flows exceeding investment costs, shareholder value increases through stock price appreciation. Several capital budgeting techniques are described like net present value, internal rate of return, payback period. Risk analysis methods in capital budgeting are also covered like sensitivity analysis, scenario analysis and Monte Carlo simulation to incorporate risk.
1. When projects we undertake deliver cash flows in which the discounted value is expected to exceed the cash used to finance the endeavor, Quaker’s economic value increases and shareholders are the immediate beneficiaries. In short, good management decisions result in stock price appreciation. The Quaker Oats Company, 1992 Annual Report.
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5. Expected Cash Flows for Projects 3 3 3 Payback period (years) 60,000 60 60 4 20 20 50 3 30 30 30 2 50 50 20 1 -100 -100 -100 0 C B A Year
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11. Project Cash Flows and NPV Calculation for Project M NPV = -35000 + 8036 + 9566 + 9965 + 10168 = 2735 10168 9965 9566 8036 -35000 Present Value of cash flow (12%) 16000 14000 12000 9000 -35000 Net cash flows 15000 14000 12000 10000 Cash inflows, CF 1 1000 -1000 Changes in net Working capital -35000 Initial Cost, C 0 4 3 2 1 0 Time T (years)
21. Purchase price of Copper Mine = Rs. 500000 Cost of Capital = 10% Life = 1 year Plan S Purchase cost of Fleet = Rs. 500000 Net Cash flows = Rs. 1280000 Plan L Installation Cost of Conveyor Belt = Rs. 4500000 Net Cash flow = Rs. 6000000
22. Net Present Value Project S Cost of the Project = Rs. 500000 + Rs. 500000 = Rs. 1000000 NPV = 1280000 (PVIF 10%, 1year ) – 1000000 = 1280000 (0.9091) – 1000000 = 163648. Project L Cost of the Project = Rs. 500000 + Rs. 4500000 = Rs. 5000000 NPV = 6000000 (PVIF 10%, 1year ) – 5000000 = 6000000 (0.9091) – 5000000 = Rs. 454600.
27. Cash Flow 16.96% 13136 104000 (65000) Project L 20.89% 11783 (20000) (30000) (40000) (65000) Project E IRR NPV 3 2 1 0 Years
28. The use of the NPV method to compare projects implicitly assumes that the opportunity exists to reinvest the cash flows generated by a project at the cost of capital, while use of the IRR method implies the opportunity to reinvest at the IRR.
29. Modified Internal Rate of Return Future value at the end of the project of all cash flows (except initial investment) at the cost of capital. FV E = (40000)(FVIF 10,2 ) + (30000)(FVIF 10,1 )+ 20000 = 101400. MIRR:- 65000 = 101400 / PVIF MIRR,3 = 15.98%.
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38. When projects we undertake deliver cash flows in which the discounted value is expected to exceed the cash used to finance the endeavor, Quaker’s economic value increases and shareholders are the immediate beneficiaries. In short, good management decisions result in stock price appreciation. The Quaker Oats Company, 1992 Annual Report.
39. Strong cash flow over the long term is [Quakers managers’] primary objective. Thus, along with management judgment, cash flow analysis is the critical yardstick used in allocating corporate resources. It takes investments in fixed and working capital to support a profitable and growing business… initially these investments may inhibit cash flow but are absolutely essential for building future profitable growth. The market evaluates the Company’s ability to invest in projects that generate superior cash flows, and shareholders reap the benefits of greater stock price appreciation.
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50. A lathe for trimming molded plastics was purchased 10 years ago at a cost of Rs. 7500. The machine had an expected life of 15 years at the time it was purchased, and management originally estimated, and still believes, that the salvage value will be zero at the end of the 15-year life. The machine is being depreciated on a straight line basis; therefore, its annual depreciation charge is Rs. 500, and its present book value is Rs.2500. The R& D manager reports that a new special-purpose machine can be purchased for Rs. 12000 (including freight and installation), and, over its five-year life, it will reduce labor and raw materials usage sufficiently to cut annual operating costs form Rs. 7000 to Rs.4000. It is estimated that the new machine can be sold for Rs. 2000 at the end of five years; this is its estimated salvage value. The old machine’s actual current market value is Rs. 1000, which is below its Rs. 2500 book value. If the new machine is acquired, the old lathe will be sold to another company rather than exchanged for the new machine. The company’s corporate tax rate is 40 percent, and the replacement project is assumed to be of average risk. Net working capital requirements will also increase by Rs. 1000 at the time of replacement.