University of Abdelhamid Ibn Badis, Mostaganem.

Economics, Commerce and Management sciences' College.

English for Businesses' Lectures.

T02/ Financial planning

Financial planning involves calculating whether new projects would be profitable. We

A
have to calculate the probable rate of return: the amount of income we’d receive each
year from the investment, expressed as a percentage of the total amount invested. If we’re
going to finance a project with our own money, the rate of return must be at least as high
as we could get by making another risk-free investment, like buying government bonds.

If we need to borrow money to finance a new investment, its projected rate of return
has to be higher than the cost of capital—the amount we have to pay to borrow the
money.

B Discounted cash flows

We usually calculate the discounted cash flow value of an investment. This means
discounting or reducing future cash flows to get their present values—in other words,
calculating the present value of money to be received in the future. This is because the
value of money decrease over time. Firstly, there’s nearly always inflation, so cash will
have lower purchasing power in the future: you’ll be able to buy less with the same
amount of money. And secondly, if you had the money now, you could get income by
using or investing it. The return we could get by investing the money in other ways is the
opportunity cost of capital. So waiting for money is also a cost. This is the time value of
money: how much more it is worth to receive money now rather than in the future.

C Comparing investment returns.

If we have to choose among possible investment in new projects, we work out the net
present value (NPV) of each project by adding up all the expected cash flows, discounted
to their present value, minus the initial investment. To do this, we have to select a
discount rate or capitalization rate. This is usually the interest rate we pay for borrowing
the capital, but we could increase it if there’s a lot of uncertainty or risk.
n
NPV = (  cf i  1  r n )-I0
i 1

When we are comparing alternative investments, we also calculate the internal rate of
return (IRR). That’s the interest rate or discount rate that gives a net present value of zero
in today’s money values. We normally choose the investment with the highest IRR.

Prof. Maarfia.
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