Attribution Non-Commercial (BY-NC)

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Attribution Non-Commercial (BY-NC)

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The Team

Financial Management

Presented by: Krishna Jalan Snehal Khannukar Sowmya C G Chandasish Baissya Shrey R Dhanawadkar

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Intro:

Factors

Decision Making Criteria

Types of Projects:

Process Evaluation Criteria

Discounting Criteria:

NPV IRR PI

Non-Discounting Criteria:

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PBP ARR

Definition

maximize profits.

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Availability of funds.

Structure of capital. Taxation policy. Government policy. Lending policies of financial institutions. Immediate need of the project.

Contd

The Ideal Evaluation Method should:

of the project.

b) Consider the Time value of money. c) Incorporate the Required rate of return on the project.

Independent projects.

Mutually exclusive projects. Contingent Investments.

The Process

PROPOSALS

PLANNING PHASE

PROPOSALS

EVALUATION PHASE

PROJECTS

SELECTION PHASE

ACCEPTED PROJECTS

IMPLEMENTATION PHASE

ONLINE PROJECTS

CONTROL PHASE

PROJECT TERMINATION

AUDITING PHASE

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EVALUATION CRITERIA

DISCOUNTING CRITERIA

DISCD PBP

MODIFIED IRR

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PAYBACK PERIOD

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Discounting Criteria

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Decision Rule:

If NPV is positive, Accept.

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Year 0 1 2 3 4 5

6 TOTAL NPV

349

0.456

159.144 251.952

Difficult to ascertain future cash flows.

Demerits

Relies on discount rate and estimated cash flows.

Merits

May not give reliable results while dealing with projects under unequal project life.

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It is the discount rate at which the present value of cash inflows equals the present value of cash outflows. i.e. NPV = 0

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Year 0 1

2

3 4 5 6

246

325 385 467 349

0.709

0.565 0.448 0.366 0.300

174.414

183.625 172.48 170.922 104.7

TOTAL NPV

(1.015)

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Considers Working

Demerits

Merits

Capital and Scrap value Considers cash flows during the whole project life.

Lengthy, Based on trial & error Assumes that future cash flows are reinvested at the rate equal to IRR NPV is more reliable.

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The calculation of the IRR implicitly assumes that the cash flows are reinvested at the IRR. This may not always be realistic.

Percentages can be misleading (would you rather

NPV and IRR do not always select the same project in mutually exclusive decisions.

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9-22

compound average annual rate that is calculated with a reinvestment rate different than the projects IRR.

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MIRR also avoids the problem of multiple IRRs. Managers prefer MIRR method better for this than IRR.

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Profitability Index

The Ratio of payoff to investment. Also known as The Benefit cost ratio is the present value of forecasted future cash flows divided by the initial investment:

PROFITABILITY INDEX

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Year

Cash Flows

NPV @ 14%

PV @ 14%

0

1

-1100

358

1.000

0.877

-1100

313.966

2

3

246

325

0.769

0.675

189.174

219.375

4

5 6

385

467 349

0.592

0.519 0.456

227.92

242.373 159.144

1351.93

Accept the project when PI is greater than one. PI > 1 Reject the project when PI is less than one. PI < 1 May accept the project when PI is equal to one. PI = 1

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Allows comparison of

Undertakes Time value

profitability

Demerits

Potential Ranking

Merits

of money

Problems

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the present value basis.

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Discounted Payback

(500) 0 250 1 250 250 250 250 2 3 4 5 Discounted CF

0 1 -500 250

@ (14%)

-500.00 219.30 1 year The Discounted280.70 Payback is 2.52 years 2 250 192.38 2 years 88.32 3 250 168.75 .52 years

Demerits

Merits

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Payback Period

ips

INITIAL INVESTMENT

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Cash out flow = 1100 crores Cash IN Flow Year 1st Year 2nd Year 3rd Year 4th Year 5th Year 6th year Amt in crore 358 246 325 385 929 + 171/385 =0.44 3 years

0.44

Simple.

DISADVANTAGES ADVANTAGES

ips

Fails to consider time value of the money Based on the principle of rule of thumb.

No recognition for the pattern of cash flows & its timing.

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Project Investment is judged by looking at its rate of return on book value. Evaluates return on accounting profits. i.e. on accrual basis. Annual returns are expressed in percentage of net investment.

AVERAGE INVESTMENT

100

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Project A: Step 1: Annual Depreciation = Step 2: Year Cash Inflow (+) Salvage Value (+) Depreciation* Accounting Income Step 3: Average Accounting Income

( 16 + 60 + 45 ) 3 40.333 220 = 40.333 = 8.3%

Project B: Step 1: Annual Depreciation = ( 198 18 ) / 3 = 60 Step 2: Year 1 2 3 Cash Inflow 87 110 84 Salvage Value 18 Deprecation* -60 -60 -60 Accounting Income 27 50 42 Step 3: Average Accounting Income = ( 27 + 50 + 42 ) = 39.666 3 Step 4: Accounting Rate of Return = 39.666 =20.0% 198

It can be affected by noncash items such as depreciation & bad debts

Simple.

ips

Demerits

Merits

Easy to calculate using the accounting data. Ensured earnings of profitability of the project using net earnings concept.

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Ignores the fact that profits earned can be reinvested. Can be calculated in a wide variety.

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ips

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