Chương 3

Present Value – earlier money on a time line

Future Value – later money on a time line
Interest rate – “exchange rate” between earlier
money and later money
o Discount rate
o Cost of capital
o Opportunity cost of capital
o Required return

3.1.2. Compound interest vs Simple

interest
 Simple interest: Interest earned only on the original
principal amount invested.
 Compound interest: Interest earned on both the
initial principal and the interest reinvested from prior
periods

3.1.3. Future Values: Compound

interest
Suppose you invest $1,000 for one year at 5% per year.
What is the future value in one year and in 2 years?
FVn = PV * (1 + r) t = 1000 * (1+0.05)2 = 1,102.50
Principle Interest Future value
1 $1,000 $50 $1,050
2 $1,050 $52.5 $1,102.50
General Formula
FV = PV(1 + r)t
o FV = future value
o PV = present value
o r = period interest rate, expressed as a decimal
o t = number of periods
Future value interest factor = (1 + r)t

3.1.4. Present Values

How much do I have to invest today to have some
amount in the future?
o FV = PV(1 + r)t r: require return/cost of capital/discount rate
o Rearrange to solve for PV = FV / (1 + r)t
When we talk about discounting, we mean finding the
present value of some future amount.
When we talk about the “value” of something, we are
talking about the present value unless we specifically
indicate that we want the future value.

Eg: Suppose you need $10,000 in one year for the down
payment on a new car. If you can earn 7% annually,
how much do you need to invest today?
r: require return/cost of capital/discount rate -> PV=10000/(1=7%)^1
You want to begin saving for your daughter’s college
education and you estimate that she will need
$150,000 in 17 years. If you feel confident that you
can earn 8% per year, how much do you need to
invest today? -> PV=150000/(1+8%)^17=40.51
Your parents set up a trust fund for you 10 years
ago that is now worth $19,671.51. If the fund
earned 7% per year, how much did your parents
invest? -> pv= 19,671,51/(1+7%)^10=10000

The Basic PV Equation - Refresher

PV = FV / (1 + r)t
There are four parts to this equation
o PV, FV, r and t
o If we know any three, we can solve for the fourth

Discount Rate
Often we will want to know what the implied interest
rate is on an investment
Rearrange the basic PV equation and solve for r
o FV = PV(1 + r)t
o r = (FV / PV)1/t – 1
If you are using formulas, you will want to make use
of both the yx and the 1/x keys

3.1.6. Annuities and Perpetuities

Annuity: finite series of equal payments that occur at
regular intervals.
Perpetuity – infinite series of equal payments

3.2.1. Where do the CFs come from?

 Sales and other revenues
 Cost of sales and expenses
 Depreciation
 Working capital
 Taxes

Costs
 Costs contribute to CF negatively by a factor of (1-
tc)
 That is, every $1 increase (decrease) in costs
means a decrease (increase) in CF of $(1-tc)
 All “real” CFs are multiplied by (1-tc)

Depreciation
 Not a real CF
 However, important because it provides a tax
shelter and tax savings
Depreciation affects CF positively by reducing
taxable income
=> reduced taxes, which is like an increase in CF
 Every $1 increase (decrease) in depreciation
means an increase (decrease) in CF of $tc

Taxation
Three major impacts:
1. Income tax represents a cash outflow
2. Tax shield – depreciation provides a tax deduction
which results a tax saving
3. Capital gains tax (CGT)
Lowers the net profit made from the sale of asset
May result in a tax saving when a loss is made from the
sale of an asset

 Disposal of an asset
Generally, the sale of an asset generates:
o Gain/profit (when the asset sells for more than its book
value)
o Loss (when the asset sells for less than its book value)
Sales of an assets have taxation implications:
o A gain is subject to tax
o A loss results in a tax deduction (less tax paid)

After-tax Salvage
If the salvage value is different from the book value
of the asset, then there is a tax effect
Book value = initial cost – accumulated depreciation
After-tax salvage = salvage – tc(salvage – book value)
tC= tax rate

3.2.2. Relevant Cash Flows

The cash flows that should be included in a capital
budgeting analysis are those that will only occur (or
not occur) if the project is accepted.
These cash flows are called incremental cash flows
The stand-alone principle allows us to analyze each
project in isolation from the firm simply by focusing
on incremental cash flows.

Pro Forma Statementsand Cash Flow

Capital budgeting relies heavily on pro forma
accounting statements, particularly income
statements
Computing cash flows – refresher
o Total Project Cash Flow = OCF – net capital
spending (NCS) – changes in NWC
o Operating Cash Flow (OCF) = EBIT + depreciation
– taxes
o OCF = Net income + depreciation (when there is
no interest expense

Other Methods for Computing OCF

Bottom-Up Approach
oWorks only when there is no interest expense
o OCF = NI + depreciation
Top-Down Approach
o OCF = Sales – Costs – Taxes
o Don’t subtract non-cash deductions
Tax Shield Approach
o OCF = (Sales – Costs)(1 – T) + Depreciation*T

What to discount?
When faced with this problem, stick to three general
rules:
 Only cash flow is relevant (leave accounting income to
the accountants)
 Always estimates the cash flows on an incremental
basis
 Be consistent in your treatment of inflation.

Common Types of CFs to Watch out for

Sunk costs – costs that have accrued in the past
Opportunity costs – costs of lost options
Side effects
o Positive side effects – benefits to other projects
o Negative side effects – costs to other projects
Changes in net working capital
Financing costs
Taxes

Ignore Sunk costs

 Sunk costs are cash outflows incurred in the past
 No longer relevant to influencing whether a prospective project should be
undertaken
Consider Opportunity Costs
 Opportunity cost: Lost revenues from alternative uses
Consider Side Effects
 Positive (Synergy): a new project increases cash flows of existing projects
 Negative (Erosion): a new project decreases cash flows of existing projects
No , cho dù bạn có thực hiện hay kh thien dự án thì nó đã được trả rồi
xem xét khi bạn thực hiênj dự án bạn có mất 3tr k=> phải consider oppotunity cost
dự án mới có thể làm giảm dòng tiền của các dự
Consider Side Effects
 Positive (Synergy): a new project increases cash flows of existing projects
 Negative (Erosion): a new project decreases cashflows of existing projects
No , cho dù bạn có thực hiện hay kh thien dự án thì nó đã được trả rồi
xem xét khi bạn thực hiênj dự án bạn có mất 3tr k=> phải consider oppotunity cost
dự án mới có thể làm giảm dòng tiền của các dự án hiện tại_ relevant cash flow
NPV – Decision Rule
If the NPV is positive, accept the project
A positive NPV means that the project is expected to
add value to the firm and will therefore increase the
wealth of the owners.
Since our goal is to increase owner wealth, NPV is a
direct measure of how well this project will meet our
goal.

Internal Rate of Return (IRR)

This is the most important alternative to NPV
It is often used in practice and is intuitively appealing
It is based entirely on the estimated cash flows and is
independent of interest rates found elsewhere
3.3.2. IRR – Definition
and Decision Rule
Definition: IRR is the return that makes the NPV = 0
Decision Rule: Accept the project if the IRR is
greater than the required return

NPV vs. IRR

NPV and IRR will generally give us the same
decision
Exceptions:
o Nonconventional cash flows – cash flow signs
change more than once
o Mutually exclusive projects
• Initial investments are substantially different (issue of
scale)
• Timing of cash flows is substantially different

IRR and Nonconventional

Cash Flows
When the cash flows change sign more than once,
there ismore than one IRR
When you solve for IRR you are solving for the root
of an equation, and when you cross the x-axis more
than once, there will be more than one return that
solves the equation
If you have more than one IRR, which one do you
use to make your decision?

3.3.3. Payback Period

 How long does it take to get the initial cost back in a
nominal sense?
 Computation:
o Estimate the cash flows
o Subtract the future cash flows from the initial cost
until the initial investment has been recovered
 Decision Rule – Accept if the payback period is less than
some preset limit
 Include payback period and discounted payback period

Discounted Payback Period

Compute the present value of each cash flow and
then determine how long it takes to pay back on a
discounted basis.
Compare to a specified required period
Decision Rule - Accept the project if it pays back on
a discounted basis within the specified time

Capital Budgeting In Practice

We should consider several investment criteria
when making decisions
NPV and IRR are the most commonly used
primary investment criteria
Payback is a commonly used secondary
investment criteria
 Chương 4
Working capital management
overview
4.1.1 Definition of working capital
There are two major concepts of working capital –
net working capital and gross working capital
(called working capital)
From the financial analyst view, working capital is
involved in current assets
When accountants use the term working capital,
they are generally referring to net working capital,
which is the dollar difference between current
assets and current liabilities.

vốn luân chuyển ròng = current asset- current

liability (net working capital)
The operating cash and cash
cycle
Operating cycle: The time it takes to receive
inventory, sell it and collect on the receivables
generated from the sale
Inventory period: The time inventory sits on the shelf
Accounts receivable period: The time it takes to
collect on receivables
Accounts payable period: The time between receipt
of inventory and payment for it
Short-term financial policy
Carrying costs
o Opportunity cost of owning current assets versus
long-term assets that pay higher returns
o Cost of storing larger amounts of inventory
Shortage costs
o Order costs—the cost of ordering additional inventory
or transferring cash
o Stock-out costs—the cost of lost sales owing to lack of
Cash cycle: The time between payment for inventory
and receipt from the sale of inventory
Cash cycle = Operating cycle – Accounts payable
period
= Inventory period + Accounts receivable
period – Accounts payable period
 The cash cycle measures how long we need to
finance inventory and receivables
inventory, including lost customers
note: 2 different things: -financial policy have to decide
the side of firm investment in curent asset
-involve in (how much inventory u have)[ bạn phải đầu tư bao
nhiêu cho tsan ngắnhanj dó)
-Bạn sử dungj nguồn vốn nào để tài tợ cho các tsan ngắnhanj đó
4.2.2. No More Cash Than Necessary
 When a firm holds cash in excess of some necessary b. Cash Discounts
minimum, it incurs an opportunity cost.
 If the firm maintains too small Cash discount is the percentage amount that can be
a cash balance, it may run out of cash subtract from the invoice if the customer pays within
the discount period.
4.2.3. Cash Management Cash discount may vary according to the buyer’s
Collection of Cash: creditworthiness and payment history, order size and
o speed up collections and reduce the lag between season
the time customers pay their bills and the time
the cash becomes available. c. Credit instrument
Disbursement of Cash: The credit instrument is the basic evidence of
o control payments and minimize the firm’s costs Indebtedness
associated with making payments. công cụ tín dụng , bằng chứg thẻ hiện cho khoản nợ :
như commercial draft, thương phiếu, chấp phiếu....
4.3. Components of credit policy
Terms of sale: The conditions under which a firm sells 4.3.2. Analyzing Credit Policy
its goods and services for cash or credit. In evaluating credit policy, there are five basic factors to
Credit analysis: The process of determining the consider:
probability that customers will not pay. Revenue effects
Collection policy: The procedures followed by a firm Cost effects
in collecting accounts receivable. The cost of debt
chính sách tín dụng The probability of nonpayment
cung cấp tín dụng cho khách hàng vì : The cash discount
+ recieve the revenu( tăng doanh số)

C
4.3.1. Terms of the Sale o
a. The credit period ll
b. The cash discount and the discount period. e
c. The type of credit instrument c
“2/10, net 60” means that customers have 60 days ti
from the invoice date to pay the full amount; however, o
if payment is made within 10 days, a 2 percent cash n
discount can be taken.
For example: an order for $1,000, with the terms of the

Effort:
1. Send out a delinquency letter informing the
customer of the past-due status of the
account.
2. Make a telephone call to the customer.
3. Employ a collection agency.(trung gian thu hồi nợ)
4. Take legal action against the customer.

a. Credit Period
Credit period is the basic length of time for which
credit is granted.
The invoice date is the beginning of the credit period
- the shipping date or the billing date.
 b.
The

economic order quantity

model
Inventory costs Assumptions:
Storage and tracking costs. o This model requires a near perfect forecast of
Insurance and taxes. inventory unit demanded, T and a constant rate of
Losses due to obsolescence, deterioration, or theft. inventory usage.
The opportunity cost of capital on the invested o Constant or fixed order cost, F, and a constant cost
amount. of holding each item of inventory, CC.
Other types of cost: restocking costs and costs o The corporation received its ordered inventory
related to safety reserves, carrying costs. when the inventory is exhausted
Inventory Management o The ordered inventory are used up a constant rate.
Techniques EQQ model: slide
a. The ABC Approach
b. The Economic Order Quantity Model
a. The ABC Approach
 The basic idea is to divide inventory into three (or
more) groups.
A small portion of inventory in terms of quantity
might represent a large portion in terms of inventory

value.