Financial policy

Disponible uniquement sur Etudier
  • Pages : 10 (2418 mots )
  • Téléchargement(s) : 0
  • Publié le : 20 novembre 2010
Lire le document complet
Aperçu du document
Capital Budgeting

Capital Budgeting

In the process of maximizing wealth, both households and corporations must invest An investment is defined as a change in the investor’s stock of Real assets Financial, or derivative assets

Capital Budgeting
Capital budgeting is defined as  The process of planning expenditures on assets whose cash flows are expected to extendbeyond one year By convention, the process is referred to as financial asset valuation when it deals with financial, or derivative assets, and as Capital Budgeting when it deals with real assets

Capital Budgeting
Comparing processes: Real Assets
Determine the cost of the investment project Estimate expected cash flows including salvage value Determine the riskiness of the cash flows Determinecost including risk premium Estimate the NPV of cash flows Compare NPV of inflows and outflows

Financial Assets
Determine the price that must be paid for the asset Determine future interest or dividend payments and expected sales price Determine the riskiness of the cash flows Determine cost including risk premium Estimate the NPV of future interest or dividend payments Compare NPV of inflowsand outflows

Capital Budgeting

The corporation’s long-run targets concerning its competitive edge, survival and growth are spelled out in its Strategic Business Plan The strategic business plan is therefore the source of a number of potentially profitable investment opportunities that can be translated into a set of capital expenditure proposals

Capital Budgeting
Capital expenditureproposals will, normally, be related to the following objectives: 1.Replacement to maintain current productive capacity) 2.Replacement to reduce cost, or introduce technological innovations 3.Expansion of productive capacity 4.Expansion into new products or markets


Capital Budgeting Decision Rules
The corporation’s capital expenditure proposals are subsequently analyzedin terms of profitability, and evaluated in accordance with a set of capital budgeting decision rules, such as The Payback Period, or Discounted Payback Period method

The Net Present Value (NPV) method
The Internal Rate of Return (IRR), or Modified Internal Rate of Return (MIRR) method

Capital Budgeting Decision Rules
The Capital Budgeting Decision Rules are all based on analyzing thefree cash flow associated with each capital expenditure proposal. Typically, these analyses include three fundamental elements: 1. Initial investment outlay
2. Operating cash flows over the project’s life (aftertax operating income plus depreciation) 3. Terminal cash flows, including salvage

Free Cash Flow – an example
The Macrohard Corporation has developed a “smartbox” for managing homeelectronics in the residential markets. A feasibility study based on extensive marketing surveys offers a sales forecast of 100 000 units per year a an average price of CAD 300 per unit. Given the rate of technological progress, Macrohard expects the project to have a four-year life.
The per unit production cost has been estimated at CAD 140, R&D expenditures at 18 million dollars, while initialproduction equipment expenditures will amount to 10 million dollars. An annual fixed cost of selling and administration is estimated at 3 million dollars.

Free Cash Flow – an example

Sales COGS Gross Margin Selling, General, Aministration R&D Depreciation EBIT Corporate Tax (40%) Unlevered Net Income

30000 -14000 16000 -3000 -18000 -18000 7200 -10800 -2000 11000 -4400 6600

30000 -1400016000 -3000 -2000 11000 -4400 6600

30000 -14000 16000 -3000 -2000 11000 -4400 6600

30000 -14000 16000 -3000 -2000 11000 -4400 6600


-2000 -2000 800 -1200

Free Cash Flow – an example
From the table, it follows that the calculation of unlevered net income from a given investment proposal can be generalized as follows:

EBIT  (1  tc )  (Re venue  Cost  Depreciation)  (1 ...
tracking img