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PRODUCT DEVELOPMENT “ Creating Value Internally”

PRODUCT DEVELOPMENT “ Creating Value Internally”. TYPES OF CAPITAL EXPENDITURES. PURCHASE NEW EQUIPMENT REPLACE EXISTING ASSETS INVESTMENTS IN WORKING CAPITAL MERGER AND ACQUISITION ANALYSIS. THE CAPITAL BUDGETING PROCESS. GENERATE PROJECT PROPOSALS ESTIMATE CASH FLOWS

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PRODUCT DEVELOPMENT “ Creating Value Internally”

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  1. PRODUCT DEVELOPMENT“Creating Value Internally”

  2. TYPES OF CAPITAL EXPENDITURES • PURCHASE NEW EQUIPMENT • REPLACE EXISTING ASSETS • INVESTMENTS IN WORKING CAPITAL • MERGER AND ACQUISITION ANALYSIS

  3. THE CAPITAL BUDGETING PROCESS • GENERATE PROJECT PROPOSALS • ESTIMATE CASH FLOWS • EVALUATE ALTERNATIVES • SELECT PROJECTS

  4. ESTIMATINGCASHFLOWS • CASH FLOWS MUST BE INCREMENTAL • USE AFTER TAX CASH FLOWS • INDIRECT EFFECTS MUST BE INCLUDED • SUNK COSTS MUST NOT BE CONSIDERED • USE OPPORTUNITY COSTS TO MEASURE VALUE OF RESOURCES

  5. NET INVESTMENT IS THE INITIAL CASH OUTLAY PROJECT COST PLUS SHIPPING AND INSTALLATION PLUS INCREASES IN NET WORKING CAPITAL MINUS PROCEEDS FROM SALE OF EXISTING ASSETS MINUS TAXES ASSOCIATED WITH SALE OF OLD EQUALS NET INVESTMENT

  6. CASH FLOWS AFTER TAX • CHANGE IN REVENUE • LESS: CHANGE IN OPERATING COSTS • LESS: CHANGE IN DEPRECIATION • EQUALS: CHANGE IN OPERATING EARNINGS • LESS: TAXES • EQUALS: CHANGE IN AFTER TAX OPERATING EARNINGS • PLUS: CHANGE IN DEPRECIATION • LESS: CHANGE IN NET WORKING CAPITAL • EQUALS: NET CASH FLOW

  7. DECISIONCRITERIA • NET PRESENT VALUE • INTERNAL RATE OF RETURN • PROFITABILITY INDEX • PAYBACK PERIOD

  8. NET PRESENT VALUE Present value of an investment = discounted value of cash flows- investment PV = future cash flows - Investment = + + + -

  9. DF = DISCOUNT FACTOR the amount by which cash flows received in the future lose value

  10. DISCOUNT FACTOR Discount Factor for cash flows discounted for one year at 10% DF= 1/1.10 = .909 Discount Factor for cash flows discounted for two years at 5% DF= 1/(1.05)2= .952

  11. NPV- EXAMPLE PV= (CFAT)/(1+R)N + (CFAT)/(1+R)N+1 PV =(100)/(1.10)1 + (100)/(1.10)2 PV= (100)(.909) + (100)(.826) PV= 173.50

  12. SUBTRACT NET INVESTMENT Net investment is the initial cash outlay for the project Discounted Cash Flow - Investment= NPV Decision Rule: If NPV> 0, Accept Project

  13. NPV - EXAMPLE IF NINV IS $150, THEN; NPV = $173.50 - 150 = $23.50

  14. INTERNAL RATE OF RETURN The interest rate that equates DCF with Net Investment $100/(1+ R)1 + $100/(1+R)2 = $150 IRR = .10

  15. PAYBACK PERIOD (PB) PB = NET INVESTMENT/ANNUAL CASH FLOWS PB = $150/$100 = 1.50 YEARS

  16. PROFITABILITY INDEX PI= PV of CASH FLOWS NINV PI = $90.90 + $82.60 = 1.16 $150

  17. Management 290 business policy exercise Calculate the net present value of a project with a net investment of $20,000 for equipment and an additional net working capital investment of $5,000 at time zero. The project is expected to generate net cash flows of $7,000 per year over a 10 year period. In addition the working capital will be recovered at the end of the tenth year. The required rate of return on the project is 11%. What is the meaning of the computed net present value figure.

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