Business Finance Summary
Business Finance, Investors, Firms and Markets
• Investments in assets are important because assets generate the cash flows that are needed to meet operating expenses and provide a return to owners of the business.
• Financing decisions involved generating funds internally or form external sources to the business. Such as by issuing debt or equity securities.
• Financing charges amount to non-operating cash flows
• The required rate of return caters for the costs to both shareholders and debt holders for funds committed to the project. Therefore, using the required rate of return involves the financing charges being incorporated into the discount rate NOT ...view middle of the document...
IF A CAPITAL MARKET DOESN’T EXIST SHAREHOLDERS CANNOT AGREE ON A INVESTMENT DECISION
Accounting rate of return - is the ratio of average annual earnings to initial outlay. Another is the ratio of average annual earnings to average investment in the project.
Payback Period – Time it takes an entity to recover the projects initial cash outlay. Time value of the money is not considered in the payback period.
Capital Expenditure Process
• Each proposal involves making current outlays in the expectation of future cash inflows, and each can be analysed as a capital-expenditure proposal
• Capital expenditures are important for a company because the amounts of money involved are large and their effects extend well into the future
• Capital expenditure involves:
Generation of investment proposals
• What is being fixed?
Evaluation and selection of those proposals
• Nature of project and cash inflows/outflows
Approval and control of capital expenditures
• Procedures for project development
Post-completion audit of investment projects
• Provides info to enable implementation of improvements in the projects operating performance
• Improve quality of investment decisions
• Lead to re-evaluation and possible abandonment of unsuccessful projects
• Independent projects – One that may be accepted or rejected without affecting the acceptability of another project
• NPV – Difference between the present value of its net cash flows and its initial cash outlay.
where k = Required Rate of Return
Amount of positive net presents values represents the immediate increase in the companies wealth that will result from accepting the project which will increase shareholders wealth
Cash Inflows comprise of:
• Receipts from sale of physical assets
• Receipts from sale of goods and services
Cash Outflows comprise of:
• Expenditures on materials
• Indirect expenses for manufacturing, selling, administration, inventory and taxes
• Internal rate of return (IRR) – Rate of return that equates the present value of its net cash flows with its initial cash outlay.
where r is internal rate of return
Application of project evaluation methods
ROR is the return that is sufficient to compensate shareholders and debt holders for the resources committed to the project. It includes both interest paid to debt holders and returns to shareholders.
INTEREST IS NOT A CASH FLOW
Estimation of cash flows in project evaluation
• Financing charges – Interest and dividends should not be included in the calculation of a projects net cash flow because they have already been included.
Incremental cash flows
• Cash flows that only occur once the project is undertaken
Change once the project has been undertaken
Must be a cashed item
• Is it a cashed item?
• Will the item change if the project is undertaken
Costs that have already been incurred and are...