Chapter 10 (copy)

The data needed to evaluate an investment opportunity are the __***_______________________***__ related to the investment

expected cash flows

There will be __**__________**__ of cash (from sales of products/services) and there will be cash __**__________________**__ related to production and sales

\-We refer to the difference between each year’s cash receipts and cash expenditures as the __***______________***__

receipts; expenditures; net cash flow

This requires __***______________***__ of the projected cash flows for each of the years of the investment’s life

estimates

Project analysis must be able to assess whether the expected return can compensate for the risk borne

\-Internal ***“*__*____________*__*”*** assumes average firm-wide risk, must be adjusted for each individual project

\-Is the return on a specific investment opportunity great enough to __**_______________**__**?**

hurdle rate; justify the risk

The payback method of analysis evaluates projects based on how long it takes to __**__________**__ the amount of money put into the project

recover

***All things equal***, the __**__________**__ the payback period, the better

\-The sooner we recoup our investment amount, the lower the __**_____**__ from things we can’t have predicted/projected/estimated in advance

\-Furthermore, given the high cost of capital, the longer we have our initial investment tied up, the more __**_______**__ it is for us

shorter; risk; costly

It ignores __***_____________***__ after the payback period

\-Investments with long lives will not be fairly measured against investments with shorter lives

everything

It totally ignores the __***______________***__***!***

\-Given the high cost of capital, the more we have our initial investment tied up, the more costly it is for us

time value of money

Remember the economic process businesses follow →

\
*obtain capital → make* __***____________***__ *→ returns*

investments

The first step that must be taken in investment analysis is to identify the __**_______________________**__

investment opportunity

Analysis of investments in __***____________________***__ is referred to as *capital budgeting*

long term projects

Different approaches to capital budgeting

\-The __**___________**__ method

\-The net present value (NPV) method

\-The internal rate of return (IRR) method

payback

The Net Present Value method of analysis determines whether a project earns more or less than a __**________________**__ rate of return

\-Determine __***_________________***__ hurdle rate: the required rate of return given risk-return tradeoff

\-Will only accept the project if it clears this ‘hurdle’

stated desired; project-specific

•Different industries tend to have different base rates of return, as many risks are __***_______________________***__

shared/common

The NPV method compares the present value of a project’s cash inflows to the present value of its cash outflows __**_______________**__ at the project’s __**________________**__

discounted; hurdle rate

If the present value of the inflows is __**___________**__ than the outflows, then the project is profitable because by construction it is earning a rate of return that is __**__________**__ than the hurdle rate

greater; greater

We have a possible project for which we invest $10,000 today and estimate cash inflows of $6,500 at the end of each of the next two years.



Our hurdle rate is 18%.  What is the NPV?



  PV of outflows  =  __**($_________)**__



  PV of inflows  =  PV(rate,nper,pmt,\[fv\],\[type\])



  =  PV(__**____%**__, 2, __**_______**__)



  =  __**$_________**__ 



  NPV  =  PV inflows – PV Outflows

      =  $10,177 - $10,000 = __**$________**__

10,000; 18; -6500; 10,177; 177

NPV

\
Strengths

\-It considers the full __**____________**__

\-It considers the time value of money

project life

NPV



Weaknesses

\-The __**______________**__ must be determined before you can do any project analysis

\-It doesn’t indicate what __**_________________**__ a project is earning, only whether it is earning more or less than a specified hurdle rate

hurdle rate; rate of return

The Internal Rate of Return (IRR) is the rate the project is __**___________________**__ to return

expected/forecasted

Often, we may be faced with a situation in which there are a __**___________________**__ of acceptable projects we can afford to finance

\-In this case, we wish to choose the best projects

greater number

A simple way to do this is to determine the __**_________________________**__ on each project and then to rank the projects from the project with the __**___________**__ IRR to the one with the __**__________**__

internal rate of return; highest; lowest

What is the weakness to this simple approach?

\-It ignores the __**_____________**__ of each project

relative risk

Each method has clear weaknesses

\-Payback method ignores both __**__________**__ and all returns after the __**______________**__

\-NPV method requires detailed __**____________**__ in advance in order to determine hurdle rate

\-IRR method totally ignores __***_____***__

timing; payback period; risk analysis; risk

**There is no magic bullet!**

\-There is no __**____________**__ to do things that is always the best choice under every circumstance

\-KEY: Understand the costs and benefits of each method to determine which method or methods is most appropriate __***_______________________***__

one way; in each circumstance

Who sucks?

Destiny