Evaluating Capital Investment Capital Budgeting 1 Capital investment
第四章 資本投資之評估 Evaluating Capital Investment (Capital Budgeting) 1
Capital investment → output (revenue) ↑/ cost ↓ Steps in Investment Analysis: (1) identifying potentially profitable investment alternatives (2) collecting relevant data on capital outlays costs, and returns (3) using an appropriate method to analyze the data (4) deciding whether to accept or reject the investment or selecting the top ranking amons mutually exclusive projects. 2
Alternative Measures of Investment Worth : eg: A B 0 -10. 0 1 2. 5 3. 0 2 2. 5 3 2. 5 4 2. 5 2. 0 5 2. 5 5 2. 0 3
Alternative Measures of Investment Worth(續) : (1) Payback Method P=V/I V: initial investment I: annual cash return (2) Simple rate of return where It does not recognize the time value of money 4
Alternative Measures of Investment Worth(續) : (3) Discounted Cash Flow Measures A. Net Present Value (NPV) method B. Internal Rate of Return (IRR) method = ” yield ” accept NPV ≧ 0 IRR ≧ min. acceptable rate of return NPV=PV of cash inflows – initial cash outflow i = 10% NPVA = 719 NPVB = 1452 profitability index = 5
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IRR:the discount rate that gives an NPV equal to zero 7
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NPV vs. IRR NPV + 0 discount rate (i) 15. 1 12. 55 B A 9
NPV vs. IRR C NPV B 16. 6 0 15. 1 12. 55 i C B NPV↓, as discount rate↑ when IRR method is applied, the cash flow are assumed to be reinvested at the IRR rate. The conflicting rankings result from the difference between the two methods concerning the rate at which cash inflows are assumed to be reinvested. (p. 78) 10
Comparing investments with unequal lives : (p. 79) (1) longest useful life (2) lowest common denominator of their useful lives NPV$ annuity (3) NPV$ => annuity 11
Handling Risk and Uncertainty A. adjust discount rate: little risk with less discount rate B. Probability Approach =V C. Certainty Equivalent Approach Cash flow (Ei) × certainty equivalent coefficients (Ci) = certainty equivalents r: risk-free discount rate 12
Adjust Cash Flows for Inflation use real rate instead of nominal rate as the discount rate Estimating Cost of Capital K t = Wd K d + We K e weight cost of capital cost of debt capital cost of equity capital Kd = i (1 -t) + Re interest rate tax rate internal credit rationing premium for financial risk and credit reserves loss Ke = E / P + G expected growth rate earning per share net amount of capital raised per share 13
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