Fluent Essays

DB#3: Sneaker 2013 Capital Budgeting A Framework for Corporate Investments Dr. C. Bulent Aybar Professor of International Finance 1 Investment Analysis and Capital Budgeting At the beginning of the course, I emphasized three pillars of value creation: Investment Funding Distribution It is time to discuss what we mean by value creating investment. Capital Budgeting is a framework we can use to discipline our analysis to make consistent value creating investment decisions. This framework requires us to determine project cash flows and use a decision rule to determine if the project adds value to the investor’s wealth. © Dr. C. Bulent Aybar Three Stages of Project Cash Flows A typical investment project requires investment today or over a period of time until the project becomes operational. This is the investment stage where we incur sizable cash outflows to acquire land, build a plant, to purchase equipment and make working capital investments to be prepared for the operations. Once project is operational, it starts to generate revenues and incur operating costs. It is also highly plausible that the project may require new working capital and fixed assed investments during the operational period. This phase is referred to as operational stage. © Dr. C. Bulent Aybar Three Stages of Project Cash Flows While the companies are ongoing concerns, projects invested by firms are considered to have limited economic life. This fundamental assumption implicitly suggests that each project is terminated at the end of its economically useful life. Terminal stage involves liquidation of project fixed assets and working capital, environmental clean up and other expenses and may create tax liabilities or tax benefits. © Dr. C. Bulent Aybar Project Cash Flows & Decision Rules: Summary Initial Investment Operational Cash Flows Terminal Cash Flows (+) Land (+) Plant (+) Equipment +Installation (+) Working Capital Investment =Initial Outlay +Revenues -Operating Costs -Taxes +Depreciation -Change in WCR -CapEx =FCFP (+) Proceeds from liquidation (-) Tax Liability /(+) Tax Credit (+) CF from Recall of WC (=)Terminal Cash Flows Decision Rules Net Present Value Internal Rate of Return (IRR) MIRR Profitability Index Payback Period Discounted Payback Period © Dr. C. Bulent Aybar 5 Three Stages of Project Cash Flows-Expansion Project New England Casting Company is considering adding a new line to its product mix, and the capital budgeting analysis is being conducted by a group led by Nick Jordan. The production line would be set up in unused space in New England Castings main plant. The equipment’s invoice price would be approximately $200,000; another $10,000 in shipping charges would be required; and it would cost an additional $30,000 to install the equipment. © Dr. C. Bulent Aybar The machinery has an economic life of 4 years, and New England Casting has obtained a special tax ruling which places the equipment in the MACRS 3-year class. The equipment is expected to have a salvage value of $25,000 after 4 years of use. The new line would generate incremental sales of 1,250 units per year for four years at an incremental cost of $100 per unit in the first year, excluding depreciation. © Dr. C. Bulent Aybar MACRS Depreciation Tables Each unit can be sold for $200 in the first year. The sales price and cost are expected to increase by 3\% per year due to inflation. Initially, NEC invests $25,000 in WCR, but it projects the firm’s net operating working capital to be 12\% of sales revenues during the operational period. The firm’s tax rate is 21 percent, and its overall weighted average cost of capital is 10 percent. © Dr. C. Bulent Aybar Should New England Casting Company go for the investment to introduce new line of products? © Dr. C. Bulent Aybar Tasks For the proposed expansion determine: Initial investment. Operating cash inflows Terminal cash flow Using the data developed at the stage A, apply decision rules to make a recommendation to the management team. © Dr. C. Bulent Aybar Project Data and Assumptions Equipment cost $200,000 Shipping charge $10,000 Installation charge $30,000 WCR Investment at T=0 $25,000 Economic Life 4 Salvage/Liquidation Value $25,000 Tax Rate 21\% Cost of Capital 10\% Units Sold 1250 Sales Price Per Unit $200 Incremental Cost Per Unit $100 Net Working Capital (WCR) 12\% Inflation rate 3\% Initial Investment The initial Outlay is composed of fallowing: (+) Land (+) Plant (+) Equipment +Installation (+) Working Capital Investment =Initial Outlay In our example, NEC uses an idle space with no alternative use for its expansion project; therefore there are no land & plant acquisition costs, but we need to account for equipment installation and working capital investments. © Dr. C. Bulent Aybar Initial Investment The initial Outlay for NEC expansion project is composed of fallowing: Equipment Cost 200,000 Shipping Charge 10,000 Installation Charge 30,000 Net Working Capital Investment 25,000 Initial Outlay 265,000 © Dr. C. Bulent Aybar 3 Year MACRS Scheme MACRS-3 Percentage 1 0.33 2 0.45 3 0.15 4 0.07 MACRS-3 Percentage Basis Depreciation Book Value 1 0.33 240,000 79,200 160,800 2 0.45 240,000 108,000 52,800 3 0.15 240,000 36,000 16,800 4 0.07 240,000 16,800 - Note that the depreciable base includes costs that make the asset available for use such as installation and shipping costs. Operational Cash Flows We estimate the free cash flows to the project using the following structure: (+) Revenues (-) Operating Costs (-) Taxes (+) Depreciation (-) Change in WCR (-) CapEx (=) Free Cash Flows to Project © Dr. C. Bulent Aybar Operational Cash Flows   Year 0 Year 1 Year 2 Year 3 Year 4 Units 1,250 1,250 1,250 1,250 Unit price 200.00 206.00 212.18 218.55 Unit cost   100.00 103.00 106.09 109.27 Sales 250,000 257,500 265,225 273,188 Costs (125,000) (128,750) (132,613) (136,591) Depreciation (79,200) (108,000) (36,000) (16,800) EBIT 45,800 20,750 96,613 119,797 Taxes (21\%) (9,618) (4,358) (20,289) (25,157) NOPAT 36,182 16,393 76,324 94,639 Depreciation 79,200 108,000 36,000 16,800 WCR 25,000 30,000 30,900 31,827 32,783 Change in WCR (25,000) -5000 -900 -927 -955.5 Cap-Ex FCFP   110,382 123,493 111,397 110,484 Terminal Cash Flows at Liquidation The terminal cash flows of the project are composed of: (+) Proceeds from liquidation (-) Tax liablity /(+) Tax Credit (+) CF from Recall of WC (=)Terminal Cash Flows © Dr. C. Bulent Aybar Terminal Cash Flows at Liquidation The terminal cash flows of the project are composed of: (+) Liquidation/Salvage Value $25,000 (-) Book Value of Equipment 0 (=) Capital Gains $25,000 (-) Tax Liability $5,250 (+) Recall NWC $32,783 (=) Terminal Cash Flows $52,533 © Dr. C. Bulent Aybar Relevant Cash Flow for the Project Year 4 cash flows include terminal cash flows  110,484 +52,533 Year Project Cash Flow 0 (265,000) 1 110,382 2 123,493 3 111,397 4 163,016 20 Decision Rules Net Present Value Internal Rate of Return (IRR) MIRR Profitability Index Payback Period Discounted Payback Period © Dr. C. Bulent Aybar Decision Rule #1: Net Present Value 0 1 2 3 4 (265,000) 110,382 123,493 111,397 163,016 Decision Rule #1: Net Present Value The NPV of the project is positive or NPV>0  Project should be executed. We can also use =NPV function to calculate the PV of project cash flows and then subtract the initial outlay from the PV of cash flows. Decision Rule #2: IRR 0 1 2 3 4 (265,000) 110,382 123,493 111,397 163,016 Decision Rule #2: IRR There is no closed form solution for this equation; we need an algorithm to solve it. We can use =IRR function in Excel to solve the equation. IRR of the project is 30.16\% > Cost of Capital  Project Should be executed! Decision Rule #3: Modified IRR IRR assumes that investment cash flows can be reinvested at the IRR (similar to YTM of a bond); however this may be an optimistic assumption; therefore IRR may overstate the project performance. A realistic, and relatively conservative approach is to assume reinvesting the project cash flows at the cost of capital. This approach is referred to as Modified IRR or MIRR. © Dr. C. Bulent Aybar Manual MIRR Calculation Step-1: Calculate future value of all the cash flows at the end of project life assuming that they will be reinvested at cost of capital Step-2: Aggregate the future value of all cash flows Step-3: Calculate CAGR or Geometric Mean Return of the investment MIRR Calculation We can also calculate the MIRR in Excel using MIRR function; it requires MIRR Calculation in Excel: =MIRR The function requires a finance rate and reinvestment rate; finance rate is the cost of capital, reinvestment rate can be set any rate, but the general assumption is the cost of capital Profitability Index Profitability index reflects the benefit cost ratio of a project. It is the ratio of PV of project cash flows to the project cost. NEC expansion project, generates $1.50 PV per $1 invested; this suggests significant benefits for every dollar invested. It points to execution of the project © Dr. C. Bulent Aybar 28 Profitability Index Profitability index reflects the benefit cost ratio of a project. It is the ratio of PV of project cash flows to the project cost. NEC expansion project, generates $1.50 PV per $1 invested; this suggests significant benefits for every dollar invested. It points to execution of the project © Dr. C. Bulent Aybar 29 Payback Period Note that the cost for the investment, 265,000 can be recovered sometime between 2nd and 3rd year. The portion recovered in the 3 year is (265,000-233,874.50)/111,396.88=0.28. Therefore the payback period for the investment is 2 years + 0.28 years or ~2.28 years Year FCFP Cumulative FCFP 1 110,382.00 110,382.00 2 123,492.50 233,874.50 3 111,396.88 345,271.38 4 163,016.33 508,287.71 Discounted Payback Period The cost for the investment, 265,000 can be recovered sometime between 2nd and 3rd year. The portion recovered in the 3 year is (265,000-202,407)/83,694.12=0.75. The discounted payback period for the investment is 2 years + 0.75 or ~2.75 years. Year FCFP PV of Cash Flows Cumulative PV 1 110,382.00 100,347.27 100,347.27 2 123,492.50 102,059.92 202,407.19 3 111,396.88 83,694.12 286,101.31 4 163,016.33 111,342.35 397,443.66 Conclusion Given the information, NEC Expansion project is a value creating project and it should be executed. It has significantly positive NPV and MIRR well above cost of capital. Other decisions rules such as PI also points to a favorable conclusion. The payback period is relatively short, and the investment is recovered in early or mid second year. Note that the project cash flows are expected cash flows; they are the mean of a distribution and the realized cash flows may be materially different from these. It is always prudent to conduct a sensitivity analysis to understand the project risks and the conditions under which the project lead to sub optimal results. © Dr. C. Bulent Aybar Question Do you prefer a $1 project with 100\% IRR or $100 project with 10\% IRR? Why? © Dr. C. Bulent Aybar Projects with unequal economic lives So far we conveniently assumed that mutually exclusive projects we evaluated had equal economic lives. What if the economic lives of the projects are not equal? Should we still go ahead and use NPV of each project and compare them? Would this be an apples to apples comparison? What assumptions are necessary to make sound decisions? © Dr. C. Bulent Aybar Sorting out Unequal lives Two approaches: Annualized NPV or ANPV Approach Common Economic Life Approach In both cases we implicitly assume that projects can be repeated. © Dr. C. Bulent Aybar Capital Budgeting: Projects with Unequal Lives Shao Airlines is considering two alternative planes. Plane A has an expected life of 5 years, will cost $100 million, and will produce net cash flows of $30 million per year. Plane B has an expected life of 10 years, will cost $132 million, and will produce net cash flows of $25 million per year. Shao plans to serve the route for 10 years. Inflation in operating costs, airplane costs, and fares is expected to be zero, and the company’s cost of capital is 12 percent. By how much would the value of the company increase if it accepted the better project (plane)? © Dr. C. Bulent Aybar Approach-1: Annualized NPV (ANPV) This approach requires calculation of annualized contribution of the project to NPV, and implicitly assumes that project can be repeated indefinitely generating the perpetual ANPV. Three steps: Step-1: Calculate NPV for each project Step-2: Calculate annualized contributions to NPV or ANPV Step-3: Assume that annualized NPV will be created perpetually and calculate the perpetual value of each project; select the project with higher value © Dr. C. Bulent Aybar Annualized NPV (ANPV) Approach Project-A Project-B Hint: You can use PMT function in Excel to calculate ANPV; NPV is the PV Common Economic Life Approach This approach requires finding a common economic life for both projects. For instance by assuming that 5 year project can be repeated once to create a 10 year project , we can calculate NPV of both project under the assumption that 5 year project repeated once by investing the original $100m at the end of the year five. The assumption is that the project will generate same cash flows as in years 1 through 5 during years 6 through 10. If one of the projects had a 3 year economic life and the second one had 5 year economic life, the common economic life would be 15 years. In this case first project will be assumed to be repeated 5 times while the second project will be assumed to be repeated 3 times. © Dr. C. Bulent Aybar Common Economic Life Approach Common Economic Life Approach   Required Rate of Return= 12\% A B 0 -100,000,000.00 -132,000,000.00 1 30,000,000.00 25,000,000.00 2 30,000,000.00 25,000,000.00 3 30,000,000.00 25,000,000.00 4 30,000,000.00 25,000,000.00 5 -70,000,000.00 25,000,000.00 6 30,000,000.00 25,000,000.00 7 30,000,000.00 25,000,000.00 8 30,000,000.00 25,000,000.00 9 30,000,000.00 25,000,000.00 10 30,000,000.00 25,000,000.00 NPV 12,764,005.28 $9,255,575.71 In this case, project A is expected to be repeated twice; the investment is made at the end of year 5 and cash flows are expected to be repeated from years 6 through year 10 How should firms pursue investment opportunities? When there are no limits to capital budget, and the firm faces mutually exclusive projects, decision rules like NPV and IRR should guide the investment decisions. The ultimate criteria is the value created by the project! When there are no limits to capital budget, and the firm faces a number independent projects, firm should pursue all the positive NPV projects. When there are limits to capital (capital rationing), firm should adopt all the positive NPV projects until it consumes its budget. This may require optimization with capital constraints. © Dr. C. Bulent Aybar Simple Example-1: Mutually Exclusive Projects If the company can raise large amounts of money at an annual cost of 15\%, and if the investments are mutually exclusive, which project should the company undertake? Answer: Undertake investment A because it has the highest NPV, and NPV is a direct measure of the increase in wealth from undertaking the investment Investment A B C Initial Cost $ 5,500,000 $ 3,000,000 $ 2,000,000 Expected Life (yrs.) 10 10 10 NPV @15\% $ 340,000 $ 300,000 $ 200,000 PI @ 15\% 1.06 1.10 1.10 IRR 20\% 30\% 40\% © Dr. C. Bulent Aybar Example-2: Independent Projects with Capital Constraints Considering only these three independent investments, if the company has a fixed capital budget of $5.5 million, which projects should the company undertake? Investment A B C Initial Cost $ 5,500,000 $ 3,000,000 $ 2,000,000 Expected Life (yrs.) 10 10 10 NPV @15\% $ 340,000 $ 300,000 $ 200,000 PI @ 15\% 1.06 1.10 1.10 IRR 20\% 30\% 40\% © Dr. C. Bulent Aybar If the capital budget is fixed at $5.5 million, invest in C and B, and put the remaining $500,000 in A if possible. This is the bundle of investments with the highest total NPV. One can select this bundle by ranking investments by their IRR, or occasionally more accurately by their PI (or Benefit Cost Ratio or BCR) © Dr. C. Bulent Aybar Appendix-I: More on IRR Important Characteristics of IRR IRR is highly sensitive to the timing of the cash flows IRR is blind to the size of the investment; When cash flows are unconventional (i.e. project cash flows change sign more than once) IRR produces multiple solutions. It is difficult to economically interpret multiple IRRs. Under some circumstances, there is no IRR! © Dr. C. Bulent Aybar would you rather have a small project with a higher rate of return or a large project with a lower rate of return? Sometimes, the larger, low rate of return projects have the higher NPVs. 46 Project Scale and IRR-NPV Conflict As the NPV profile Shows, project B has higher NPV for discount rates between 0 and 21.83\% 47 Multiple IRR Problem Unconventional cash flows where the sign of cash flows change more than once, produce multiple IRRs. For instance the following cash flow pattern leads and IRR of 100\% and 200\%. In this case NPV profile of the project intersects the horizontal line twice: at discount rate 100\% and discount rate 200\%. © Dr. C. Bulent Aybar 48 Multiple IRR Problem 200\% 100\% 49 No IRR Problem In some cases, NPV profile may never cross the horizontal axis. 50 Appendix-II: Replacement Projects Replacement Projects The example we considered is an “Expansion Project”. In this case the company expanded its existing capacity and we evaluated if the expansion was economical in the sense that if it added value for investors. Our conclusion was affirmative as project had positive NPV and its IRR exceeded its cost of capital. Companies also frequently engage in “Replacement” projects. Replacement analysis is a little more complicated and it requires us to focus on incremental cash flows. Now we will frame the investment project as a Replacement and conduct the analysis. © Dr. C. Bulent Aybar Lasting Impressions LLC: Replacement Project Lasting Impressions (LI) Company is a medium- sized commercial printer of promotional advertising brochures, booklets, and other direct-mail pieces. The typical job is characterized by high quality and production runs of more than 50,000 units. LI has not been able to compete effectively with larger printers because of its existing older, inefficient presses. Lasting Impressions LLC The firm is currently having problems in meeting demand cost effectively and quality requirements of the industry. The general manager has proposed the purchase of one of two large, six-color presses designed for long, high- quality runs. The purchase of a new press would enable LI to reduce its cost of labor and therefore the price to the client, putting the firm in a more competitive position. LI Investment Proposals Keep the Old Equipment Replace it with highly automated press that can be purchased for $830,000 and will require $40,000 in installation cost Replace it with a less sophisticated press that can be purchased for $640,000 and requires $20,000 in installation costs. © Dr. C. Bulent Aybar Existing Equipment (Old Equipment) Old press Originally purchased 3 years ago at an installed cost of $ 400,000, it is being depreciated under MACRS using a 5- year recovery period. The old press has a remaining economic life of 5 years. It can be sold today to net $ 420,000 before taxes; if it is retained, it can be sold to net $ 150,000 before taxes at the end of 5 years. © Dr. C. Bulent Aybar 5 Year MACRS – 20\% 32\% 19\% 12\% 12\% 5\% 56 Alternative-1: Press-A This highly automated press can be purchased for $ 830,000 and will require $ 40,000 in installation costs. It will be depreciated under MACRS using a 5- year recovery period. At the end of the 5 years, the machine could be sold to net $ 400,000 before taxes. If this machine is acquired, it is anticipated that the current asset changes on the left would result: Cash $25,400 A/R $120,000 Inventories ($20,000) A/P $35,000 © Dr. C. Bulent Aybar 57 5 Year Modified Accelerated Cost Recovery System (MACRS) Depreciation MACR-5Yr 1 20\% 2 32\% 3 19\% 4 12\% 5 12\% 6 5\% Alternative-2: Press-B This press is not as sophisticated as press A. It costs $640,000 and requires $20,000 in installation costs. It will also be depreciated under MACRS using a 5- year recovery period. At the end of 5 years, it can be sold to net $ 330,000 before taxes. Acquisition of this press will have no effect on the firm’s net working capital investment. © Dr. C. Bulent Aybar 59 Earning Projections Before Depreciation Interest and Taxes EBITDA Year Old Press Press A Press B 1 $120,000 $250,000 $210,000 2 $120,000 $270,000 $210,000 3 $120,000 $300,000 $210,000 4 $120,000 $330,000 $210,000 5 $120,000 $370,000 $210,000 The firm is subject to a 40\% tax rate. The firm’s cost of capital, r, applicable to the proposed replacement is 14\%. 60 Tasks A. For each of the two proposed replacement presses, determine: Initial investment. Operating cash inflows Terminal cash flow B. Using the data developed at the stage A, apply decision rules to make a recommendation to the management team. © Dr. C. Bulent Aybar 61 Initial Investment Outlay Item Press A Press B Cost of Old Machine $400,000 $400,000 Cost of New Machine $870,000 $660,000 Proceeds from Old Machine $420,000 $420,000 Book Value of Old Machine $116,000 $116,000 Gains from Sale $304,000 $304,000 Tax Liability $121,600 $121,600 NWC Investment $90,400 $0 Net Initial Outlay $662,000 $361,600 Book value of the old machine: 400,000-(80,000+128,000+76,000)=116,000 400,000x0.2=80,000 400,000 x0.32=128,000 400,000x0.19=76,000 Cumulative Depreciation=284,000 62 Depreciation of The New and Old Equipment Depreciation MACR-5Yr Press A Press B Existing 1 20\% $174,000 $132,000 $48,000 2 32\% $278,400 $211,200 $48,000 3 19\% $165,300 $125,400 $20,000 4 12\% $104,400 $79,200 $0 5 12\% $104,400 $79,200 $0 6 5\% $43,500 $33,000 $0 63 Net Operating Cash Flows: Old Machine Existing Machine 1 2 3 4 5 (+) EBITDA 120000 120000 120000 120000 120000 (-) Depreciation $48,000 $48,000 $20,000 $0 $0 (=) EBIT $72,000 $72,000 $100,000 $120,000 $120,000 (-) Taxes $28,800 $28,800 $40,000 $48,000 $48,000 (=) NOPAT $43,200 $43,200 $60,000 $72,000 $72,000 (+) Depreciation $48,000 $48,000 $20,000 $0 $0 (=) NOCF $91,200 $91,200 $80,000 $72,000 $72,000 64 Net Operating Cash Flows: Press-A PRESS-A: 1 2 3 4 5 EBITDA $250,000 $270,000 $300,000 $330,000 $370,000 Depreciation 174000 278400 165300 104400 104400 EBIT $76,000 -$8,400 $134,700 $225,600 $265,600 Taxes 30400 -3360 53880 90240 106240 NOPAT $45,600 -$5,040 $80,820 $135,360 $159,360 Depreciation 174000 278400 165300 104400 104400 NOCF $219,600 $273,360 $246,120 $239,760 $263,760 65 Net Operating Cash Flows: Press-B PRESS-B: 1 2 3 4 5 EBITDA $210,000 $210,000 $210,000 $210,000 $210,000 Depreciation 132000 211200 125400 79200 79200 EBIT $78,000 -$1,200 $84,600 $130,800 $130,800 Taxes 31200 -480 33840 52320 52320 NOPAT $46,800 -$720 $50,760 $78,480 $78,480 Depreciation 132000 211200 125400 79200 79200 NOCF $178,800 $210,480 $176,160 $157,680 $157,680 66 Incremental Operating Cash Flows for Press A & B Column1 1 2 3 4 5 Existing Machine $91,200 $91,200 $80,000 $72,000 $72,000 Press-A $219,600 $273,360 $246,120 $239,760 $263,760 Press-B $178,800 $210,480 $176,160 $157,680 $157,680 Press A IOCF $128,400 $182,160 $166,120 $167,760 $191,760 Press B IOCF $87,600 $119,280 $96,160 $85,680 $85,680 IOCF=Incremental Operating Cash Flows 67 Terminal Cash Flows Terminal Cash Flows Press A Press B Old Mach. Proceeds from Liquidation $400,000 $330,000 $150,000 BV at Liquidation $43,500 $33,000 $0 Profit from Sale $356,500 $297,000 $150,000 Tax Liability $142,600 $118,800 $60,000 Net Proceeds from Sale $257,400 $211,200 $90,000 Recall NWC Investment $90,400 $0 $0 Net Terminal Cash Flows $347,800 $211,200 $90,000 Net Incremental TCF $257,800 $121,200 347,800-90,000=257,800 211,200-90,000=121,200 68 Relevant Cash Flow for the Projects Year Press A Press B 0 -$662,000 -$361,600 1 $128,400 $87,600 2 $182,160 $119,280 3 $166,120 $96,160 4 $167,760 $85,680 5 $449,560 $206,880 Year 5 cash flows include terminal cash flows 69 Cash Flows on a Time Line 70 Pay Back Period Analysis Payback Period Press A Press B 1 $128,400 $87,600 2 $310,560 $206,880 3 $476,680 $303,040 4 $644,440 $388,720 5 $1,094,000 $595,600 Cumulative Cash Flows Note that the cost for Press A (662,000) can be recovered only sometime between 4th and 5th year. The portion recovered in the 5th year is (662,000-644,440)/449,560=0.0391. Therefore payback period for the Press A is 4 years + 0.039 years or ~4.04 years. The recovery for press B is faster as initial investment of 361,600 can be recovered in 3.68 years. In calculation of the payback period, we consider only the operating cash flows for a given year. For instance, in this particular case we did not include terminal cash flows of the project in year 5 cash flows. 71 Discounted Payback Period Year Press A Press B Cumulative Cash Flows A Cumulative Cash Flows B 0 (662,000) (361,600) (662,000) (361,600) 1 112,632 76,842 112,632 76,842 2 140,166 91,782 252,798 168,624 3 112,126 64,905 364,924 233,529 4 99,327 50,729 464,251 284,259 5 233,487 107,447 697,739 391,706 Discounted Payback Period 4.85 4.72 Discounted Payback period requires discounted value of each cash flow. Each cash flow is discounted to time 0 at the cost of capital, and payback period is calculated by using these discounted cash flows. In this particular case, method favors project “B” as in the standard Payback Period method. 72 NPV Rule Investment outlay may take place at time 0, or it may spread over time. If that is the case then IO can be expressed as: NPV Analysis Year Press A Press B 0 -$662,000 -$361,600 1 $128,400 $87,600 2 $182,160 $119,280 3 $166,120 $96,160 4 $167,760 $85,680 5 $449,560 $206,880 NPVPress-A=35,738.82>NPVPress-B=30,105.88 Since both projects have 5 year life spans there is no need to consider Annualized NPV, but have we had done it, ANPV-A would have been higher than ANPV-B. 74 IRR and MIRR IRR is the rate of return that equates the present value of the project cash inflows to initial outlay; alternatively it can be described as the rate of return that satisfies NPV=0 IRR implicitly assumes that project cash flows are reinvested at the IRR If we revise that assumption and assume that cash flows are reinvested at cost of capital we get MIRR IRR Project A’s IRR is 15.8, Project B’s IRR is 17.06. Both projects have IRR above cost of Capital. If we used IRR to choose the projects, Press B would be favored by the IRR method. Note that IRR assumes that cash flows can be reinvested at the IRR. A consideration of reinvestment at cost of capital (MIRR) suggest that ranking does not change. MIRR-A=15\% MIRR-B=16\% © Dr. C. Bulent Aybar 76 Profitability Index Profitability index reflects the benefit cost ratio of a project. It is the ratio of PV of project cash flows to the project cost. LI’s two projects have PIA=1.05 and PIB=1.08 . While profitability index suggests that project B generates more value per dollar invested, the total value created by project A is higher. © Dr. … DB#3: Sneaker 2013 The objective of the Case Debriefings is to revisit the cases in light of the class discussions and demonstrate your comprehension of salient issues, frameworks used for analysis, and the implications of the courses of action considered during the case discussions. For each case, you should briefly describe the context and the problem, analytical tools used to address the problem, and critical lessons learned. In your reflection essay, you are not expected to replicate the solution. Your discussion should focus on synthesis; you should emphasize what you learned and its practical value. You should use the following outline to structure your debriefing and make sure that you address the issues outlined above. You can use graphics, tables, and charts to make your point. Outline: Case Context Problem/Analytical Issues Tools used Critical lessons learned Concluding Remarks Your debriefing should be authentic and not exceed 2 pages excluding charts and tables (12 pt characters) . You should think carefully and write effectively communicating the most critical takeaways from the case discussion.  Please submit your work in MS Word doc or docx format.