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Lecture Investment analysis & portfolio management - Chapter 7: Investment analysis

After studying this chapter you will be able to understand: Net present value – basic considerations, discounted cash flows, cash money in - cash money out, incremental cash flows, inflation effects, tax effect on cash flows, opportunity cash flows, working capital changes impact, inflation, entire life of investment, tax depreciation shield (tax effect). | Investment Analysis Lecture: 7 Course Code: MBF702 Outline RECAP NET PRESENT VALUE – Basic considerations DISCOUNTED CASH FLOWS CASH MONEY IN - CASH MONEY OUT INCREMENTAL CASH FLOWS INFLATION EFFECTS TAX EFFECT ON CASH FLOWS OPPORTUNITY CASH FLOWS WORKING CAPITAL CHANGES IMPACT INFLATION ENTIRE LIFE OF INVESTMENT TAX DEPRECIATION SHIELD (TAX EFFECT) RECAP INVESTMENT Definition Capital or revenue Investment opportunities Evaluation methods of investments ACCOUNTING RATE OF RETURN (ROCE, ROI, SRR) (Estimated total or average profits/ estimated initial total or average investment) * 100 Present value factor of rs 1 at i% (pv = 1 / (1+i)^n PAYBACK METHOD TIME VALUE OF MONEY (FV=PV (1+i)^n and PV = FV ( 1 / (1+i)^n) ANNUITY NET PRESENT VALUE - Introduction Three Step NPV Method - RECAP Draw a sketch of the RELEVANT cash inflows and outflows 2. Convert the inflows and outflows into present value figures using tables or a calculator (using given rate of return) 3. Sum the present value . | Investment Analysis Lecture: 7 Course Code: MBF702 Outline RECAP NET PRESENT VALUE – Basic considerations DISCOUNTED CASH FLOWS CASH MONEY IN - CASH MONEY OUT INCREMENTAL CASH FLOWS INFLATION EFFECTS TAX EFFECT ON CASH FLOWS OPPORTUNITY CASH FLOWS WORKING CAPITAL CHANGES IMPACT INFLATION ENTIRE LIFE OF INVESTMENT TAX DEPRECIATION SHIELD (TAX EFFECT) RECAP INVESTMENT Definition Capital or revenue Investment opportunities Evaluation methods of investments ACCOUNTING RATE OF RETURN (ROCE, ROI, SRR) (Estimated total or average profits/ estimated initial total or average investment) * 100 Present value factor of rs 1 at i% (pv = 1 / (1+i)^n PAYBACK METHOD TIME VALUE OF MONEY (FV=PV (1+i)^n and PV = FV ( 1 / (1+i)^n) ANNUITY NET PRESENT VALUE - Introduction Three Step NPV Method - RECAP Draw a sketch of the RELEVANT cash inflows and outflows 2. Convert the inflows and outflows into present value figures using tables or a calculator (using given rate of return) 3. Sum the present value figures to determine the NPV. Positive or zero NPV signals acceptance, negative NPV signals rejection 4 5 NPV Method – Basic consideration 1. Net Present Value is the "Discounted value of incremental cash flow” 2. Cash flow is: CASH MONEY IN - CASH MONEY OUT 5 6 NPV Method – Basic consideration 3. Consider only if it is an incremental cash flow, and consider all incremental cash flows: (a) not historical, or averages; (b) consider only cash flows that appear as a result of the project (c) consider the impact of the project on cash flows from other projects (d) exclude fixed or sunk costs (e) exclude allocated overhead unless it will change as a result of the project. 6 7 NPV Method – Basic consideration 4. Treat inflation consistently: Discount real cash flow by real discount rates Discount nominal cash flows by nominal discount rates Note: Revenues and costs will not necessarily react uniformly to inflation. 5. All Cash Flow should be on an After-Tax basis. Use actual tax changes when .