How to Calculate Net Present Value For example we are planning of starting a business of producing and selling pesticides.

We can estimate the initial cost with reasonable accuracy because we know what we will need to buy to begin production. Would this be a good investment? It depends, whether its value exceeds its initial cost or not. In other words, does this project has a positive NPV? As mostly companies are not routinely buy and sell in the market also there may be only few businesses who are in both production and selling business. Therefore is almost impossible to find out the exact market value of such investment. As a result, we will have to depend on other parameters to estimate the market value of our new business. We first try to estimate the future cash flows we expect to generate from this business. Then we will calculate the present value of each cash flow. Once we have these estimates we can calculate the NPV as a difference between present value of these cash flows and the initial cost of starting this business. Suppose cash revenue from this business will be $15000 per year and cost of running this business will be $6000. The business will be wind down in 6 years. Fixed assets will be worth $7000 as salvage at that time. Initial cost of launching this project is $20000 and discount rate on such new projects is 10%.CONTINUE READING
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How to Calculate Discounted Payback Period | Capital Budgeting Techniques

Posted by admin on 18 October, 2012 Comments Off This item was filled under [ Capital Budgeting Techniques, Project Analysis ]

How to Calculate Discounted Payback Period For calculating discounted payback period (DPP), we will calculate the present value (PV) of each cash flow (CF) starting from the first year as zero point. For said purpose, the management is required to set a suitable discount rate. The discounted cash flow (DCF) for each period is to be calculated using this formula: DCF = Actual Cash flows / [1 + i]^n Where, i is the discount rate; n is the period to which the cash flow belongs. The two components i.e. actual cash flows and PV factor i.e. (1 / ( 1 + i )^n ) are used in this formula. Thus DCF is the product of actual cash flows and PV factor. While calculating Discounted Payback Period we use the similar procedure that we use for calculating simple payback period except that we will use the discounted cash flows instead of actual cash flows. Discounted Payback Period calculation method is illustrated in the Example below. CONTINUE READING
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How to Calculate Payback Period | Capital Budgeting Techniques

Posted by admin on 8 October, 2012 2 Comments This item was filled under [ Capital Budgeting Techniques, Project Analysis ]

How to Calculate Payback Period-Capital Budgeting Techniques Payback period is calculated by capital invested in the project by the net annual cash flow. Average of net annual cash flows may be used if net annual cash flows are not expected to be the same. Payback Period= Initial Investment/Average Annual Cash Flows For example a Project A yields following cash flows over its 5 years life.

Year 0 1 2 3 4 5

Cash Flows $(10,000) 2,000 4,000 3,000 2,000 3,000

For computing Payback Period of Project A, first we need to calculate Net Cash Flow (NCF) of the project in each year.

Year 0 1 2 3 4 5

Cash Flows $(10,000) 2,000 4,000 3,000 2,000 3,000

Net Cash Flow $(10,000) (8,000) (4,000) (1,000) 1,000 4,000

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Independent and Mutually Exclusive Projects

Posted by admin on 5 June, 2011 2 Comments This item was filled under [ Capital Budgeting Basics, Capital Budgeting Process ]

Capital Budgeting Techniques Independent and Mutually Exclusive Projects Understanding of classification of capital budgeting projects plays a crucial role while analyzing viability of projects. A Project whose cash flows have no impact on the acceptance or rejection of other projects is termed asIndependent Project. Thus, all such Projects which meet this criterion should be accepted.

A set of projects from which at most one will be accepted is termed as Mutually Exclusive Projects. In mutually exclusive projects, cash flows of one project can be adversely affected by the acceptance of the other project. In mutually exclusive projects, all projects are to accomplish the same task. Therefore, such projects cannot be undertaken simultaneously. Hence, while choosing among Mutually Exclusive Projects, more than one project may satisfy the Capital Budgeting criterion. However, only one project can be accepted. Which project should be accepted depends on different factors like initial investment, time period required for completion, strategic importance of the project, etc. usually the project which adds more value to the business in the long run will be selected. CONTINUE

READING
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Internal Rate Of Return And Mutually Exclusive Projects

Posted by admin on 28 December, 2010 1 comment so far This item was filled under [ Capital Budgeting Basics, Project Analysis ]

Internal Rate Of Return And Mutually Exclusive Projects. Whats the Concern? While considering the mutually exclusive projects, IRR technique can be misleading. Investment projects are said to be mutually exclusive if only one project could be accepted and others would have to be rejected. NPV and IRR methods for project evaluation leads to conflicting results under following conditions: 1. The pattern of cash inflows plays an important role in project evaluation while using IRR method. i.e. The cash flows of one project may increase over time, while those of others may decrease and vice versa. The major drawback with the IRR method is that for mutually exclusive projects, it can give contradictory investment decision when compared with NPV. Consider the following example.

In the above example A and B are mutually exclusive projects. Both projects require an initial outlay of $ 1,000,000.00 but the pattern of cash inflows is different. Cash inflows for Project A are increasing over the period of time while for Project B these are declining. IRR decision rule leads to select Project A as Project A IRR>Project B IRR. But decision on the basis of NPV evaluation implies that project B is more viable. Thus on the basis of mere IRR the company may select less profitable project. CONTINUE READING
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Capital Structure and Cash Flows

Posted by admin on 21 December, 2010 6 Comments This item was filled under [ Capital Budgeting Basics ]

Capital Structure and Cash Flows On one hand, operations of the company may help in forecasting of future cash flows but in addition to this, future cash inflows and out flows can also be accessed through company capital structure. A corporation may use different combinations of equity, debt, or mixture of securities to finance its assets which is termed as Capital Structure. Companys capital structure is basically the composition of its liabilities i.e. how much the company owes to its share holders and how much to its creditors. Stake holders can easily judge the managements mind-set, strategy of running business and businesss future prospects. A companys value is affected by the capital structure it employs, therefore; while deciding capital structure, management has to consider different important factors like bankruptcy costs, agency costs, taxes, and information asymmetry.

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Cash Flow | Capital Budgeting Techniques

Posted by admin on 8 October, 2010 7 Comments This item was filled under [ Capital Budgeting Basics ]

Cash Flow Success of any business can be determined through its capacity to generate positive cash flows. Therefore, Cash inflow and outflow is considered as one of the most essential elements which gives us as idea about the continued existence of a business in future. Therefore, the stake-holders focus on two things while investing in business: first, how does business generate funds and second, where does business invest those funds for generating more. Objectives of a cash flow statement: CONTINUE READING
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Profitability Index | Capital Budgeting Techniques

Posted by admin on 28 August, 2010 5 Comments This item was filled under [ Capital Budgeting Techniques ]

Profitability Index Profitability index (PI) is the ratio of investment to payoff of a suggested project. It is a useful capital budgeting technique for grading projects because it measures the value created by per unit of investment made by the investor. This technique is also known as profit investment ratio (PIR), benefit-cost ratio and value investment ratio (VIR).

The ratio is calculated as follows: Profitability Index = Present Value of Future Cash Flows / Initial Investment If project has positive NPV, then the PV of future cash flows must be higher than the initial investment. Thus the Profitability Index for a project with positive NPV is greater than 1 and less than 1 for a project with negative NPV. CONTINUE READING
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Present Value of Multiple Cash Flows

Posted by admin on 17 July, 2010 13 Comments This item was filled under [ Capital Budgeting Basics ]

Present Value of Multiple Cash Flows We come across many cases where we have to determine the present value of series of multiple cash flows. There are two ways we can calculate present value of multiple cash flows. Either we discount back individual cash flow at a time, or we can just calculate the present values individually and add them up. Example: Suppose if we want $10,000 in one year and $15,000 more in two years. If we can earn 8% on this money, how much we need to invest today to exactly earn this much in the future? In other words, what is the present value of two cash flows at 8%. CONTINUE READING
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A f u n d f l o w s t a t e m e n t i s a s u m m a r y o f a f i r m ' s inflow and outflow of funds. It tells us from wheref u n d s h a v e c o m e a n d w h e r e f u n d s h a v e g o n e . F u n d f l o w s s t a t e m e n t c a n i n d i c a t e w h e t h e r sourc ing of funds and their use match in sensea n d a l s o r e v e a l t h e p r u d e n c e or otherwise of a firm's financing and investment decisions Thef i n a n c i a l s t a t e m e n t o f t h e b u s i n e s s i n d i c a t e assets, liabilities and capital on a particular dateand also the profit or loss during a period. But
iti s p o s s i b l e t h a t t h e r e i s e n o u g h p r o f i t i n t h e b u s i n e s s a n d the financial position is also good a n d s t i l l t h e r e m a y b e d e f i c i e n c y o f c a s h o r o f working capital in business. If the management w a n t s t o f i n d o u t as to where the cash is beingu t i l i z e d , f i n a n c i a l s t a t e m e n t c a n n o t h e l p . Therefore, a statement is prepared of the sourcesa n d a p p l i c a t i o n s o f f u n d s f r o m w h e r e W o r k i n g C a p i t a l c o m e s a n d where it is utilized. This isc a l l e d F u n d F l o w s t a t e m e n t . F u n d s F l o w St atement is an analytical tool in the hands

of f i n a n c i a l m a n a g e r . T h e b a s i c p u r p o s e o f t h i s statement is t o i n d i c a t e o n h i s t o r i c a l b a s i s t h e changes in the working capital i.e., where fundsc a m e f r o m a n d w h e r e t h e y a r e u s e d d u r i n g a g i v e n p e r i o d . T h e f u n d s f l o w s t a t e m e n t o r statement of changes in fina n c i a l p o s i t i o n i s a statement of flows, it measures the changes thathave taken place during two balance sheet dates. According to R.N. Anthony , F u n d F l o w i s a statement prepared to indicate the increase inc a s h r e s o u r c e s a n d t h e u t i l i z a t i o n o f s u c h r e s o u r c e s o f a b u s i n e s s d u r i n g t h e a c c o u n t i n g period. Fund + Flow = Fund Flow MEANING OF FUND The term fund has a variety of meaning such ascash fund, capital fund and working capital fund.1. Cash fund In a narrow sense, fund means onlycash. Cash flow statement portrays net effect of the various business transactions on cash intoaccount receipts & disbursement of cash. Thisconcept of preparing fund flow statement is notaccepted, as there are many such transactionswhich do not affect cash but represent the flow of fund .for example: purchase of furniture on creditdoes not affect cash but there is flow of fund.2. Capital fund Here fund means all financialresources used in the business, whether in theform of men, money, material, machine & others. 3. Net working capital -Net working capital meansdifference between current asset and currentliabilities .funds generally refers to cash or cashequivalent or to working capital