29 April 2015Project Evaluation1 1. Fundamentals Decision Making, Cost Theory, Break Even Analysis,...

transcript

18 April 2023 Project Evaluation 1

1. Fundamentals

Decision Making, Cost Theory, Break Even Analysis, Financial

Statements, Financial Ratios, Time Value of Money, Measures of profitability, Comparison of

Alternatives

Overview

1.1 Cost Theory, Break Even 1.2 Financial Statements 1.3 Financial Ratios 1.4 The Concept of Interest 1.5 Profitability Measures 1.6 Comparison of investment

alternatives

You learn by reading the text, but also by thinking!

Decision Making

Rekognize/Analyze Decision Problem Define Goal (What) Data Collection Identify Alternatives (How) Select Criteria(s) Assess Risk Make Decision/Select best alternative

Capital Budgeting Decisions

Analyze (see previous slide) Design (loops always necessary) Plan/Market/Finance/Negotiate Invest! Operate/Manufacture => Profit = Economic

Sustainability

Cost Concepts

Variable and Fixed Cost Net Profit Contribution Break Even Analysis Economics of Scale Average and Marginal Cost Sunk Costs and Opportunity Costs

Variable and Fixed CostsOperational Costs EstimatesCase Study Example

Variable Costs: Raw Materials 1.4 KUSD/tonLabour Cost 1.2 "Transportation 0.4 "Variable Cost Total 3 "

Fixed Costs:Maintenance 5 MUSD/yearHousing 3 "Management 9 "Sales 3 "Fixed Costs Total 20 "

Break Even Analysis

Net Profit Contribution (to cover Fixed Cost)

Price Elasticity Optimizing Production Annuity of Investment Cost Economics of Scale

Net Profit ContributionVariable Costs:

Raw Materials 1.4 KUSD/tonLabour Cost 1.2 "Transportation 0.4 "Variable Cost Total 3 "

Fixed Costs:Maintenance 5 MUSD/yearHousing 3 "Management 9 "Sales 3 "Fixed Costs Total 20 "

Sales Price: 15 KUSD/tonNet Profit Contribution 12 "

Break Even Analysiswithout investment costs:

Future Sales Price 15 KUSD/tonNet Profit Contribution 12 "Break Even Quantity 1.7 Ktons/year

Break Even Analysiswith investment costs:

Annuity of Loans 80 MUSD/yearProfit requirement 40Fixed Costs incl annuity 140 "Break Even incl. annuity 12 Ktons/year

Break Even Example

MUSD/year

250 Revenue

200 Variable + Fixed Cost

150Fixed Cost incl. annuity

2.5 5.0 7.5 10.0 12.5 15.0Ktons/year

Break Even Analysis Graphics

Economics of Scale

MUSD/year

250 RevenueLower fixed Cost but

200 higher Variable Cost (less automated)

100 Variable + Fixed Cost

50 Fixed Cost incl. annuity

2.5 5.0 7.5 10.0 12.5 15.0Ktons/year

Massive and mighty!

Financing

Equity (Shareholders Funds) Loans:

Regular Annuity Bullet Baloon

Criteria / Measures

Return on Investment (/Equity) Pay Back Period Financial Statements NPV, IRR, B/C .... Multi Criteria Decision Making Risk Factor Efficient Frontier (Pareto)

Financial Statements

Statement of Earnings/Operating Statement

Statement of Cash Flow/Source & Allocation of Funds

Balance Sheet Financial Ratios (Assets, Debt,

Liquidity, Profitability, Market Value)

Operating Statement Revenue/Income - Costs => EBITDA - Depreciation, Inventory Movement,... - Interest of Loans => Profit before Tax (EBT) - Income Tax - Dividend =>Net Profit/Loss

Cash Flow

Equity Drawdown Dividend

Taxes Interest &Repayment

Loans Drawdown

Sales Costs

Investment

Shareholders

Government Deb t Holders

Company Cash Account

Customers Suppliers

Fixed Assets

Source&Application of Funds 1

Profit before Tax (from Op Statem) + Depreciation => Funds from Operations + Loans & Equity Drawdown => Funds for Allocation

Allocation: Investment Repayment of Loans Paid Taxes Paid Dividend

=> Total Allocation of Funds

Changes in Net Current Assets: Funds – Allocation

Analysis: Changes in Cash Account Changes in Debtors Changes in Inventory Changes in Creditors

Alternative Cash Flow

EBITDA - Changes in Debtors + Creditors

=> Cash Flow before Tax (Project) - Interest & Repayment of Loans

=> Free (Net) Cash Flow (Equity) - Paid Dividend + Drawdowns – Investment

=> Cash Account Movement18 April 2023 Project Evaluation 22

Balance Sheet Assets: Current Assets:

Cash Account Account

Receivable Inventory

Total Current A Fixed Assets => Total Assets

Debt & Capital: Current Liabilities Long Term Debt

Total Debt Equity Profit & Loss Bal

Total Capital => Debt &

Capital18 April 2023 Project Evaluation 23

Financial Ratios

Debt Management (DR, DSC, LLCR) Liquidity (Current Ratios) Asset Management (Turnover

Ratios) Market Value (P/E, Internal Value) Profitability (ROI, ROE)

The Concept of Interest

Time Value of Money Present and Future Value

Calculations Net Present Value (NPV) of Cash

Flow Series Profitability Measures Comparison of alternatives

Time Value of Money

Amount today is not equal to same amount after n years

Many reasons: Opportunity to earn interest Inflation Risk Impatience?

Present and Future Values

Present Value: P, Future Value: F Interest Rate per year: r Future Value after 1 year: F = P*(1+r) After 2 years: F2 = P*(1+r)*(1+r) After n years: Fn = P*(1+r)^n Present Value of F: Pn = Fn / (1+r)^n

Net Present Value of Cash Flow Series

Invested Capital is Cash Flow out Operations generate Cash Flow in Annual cash in/out: An Net Present Value:

NPV = Sum(An/(1+r)^n) Should be > 0

NPV Example, Project A:

Interest rate = 10% Invested Capital year 0 : -100 MUSD Operations years 1-5 => +30 “ NPV: Year 0: -100 year 1: +30/(1+0.1) = 27.3 year 2: +30/(1+0.1)^2 = 24.8 etc

NPV Example:Interest

Project A: 10%Year Cash Flow Present Accum.

n An: Value: NPV0 -100 -100.0 -100.01 30 27.3 -72.72 30 24.8 -47.93 30 22.5 -25.44 30 20.5 -4.95 30 18.6 13.7

Sum: 50 13.7Internal Rate of Return 15.2%

Profitability Measures Net Present Value Pay Back Period, discounted Annual Worth / Annuity Benefit / Cost Ratio Internal Rate of Return (IRR) Relation of IRR to NPV

Profitability measures for the Example Pay Back Period undiscounted = 4 years Pay Back Period discounted = 5 years Annuity of -100 MUSD = 26.4 Annual Cash Flow in = 30.0 Annual Net Worth = 3.6 Benefits = NPV of 30 in 5 years = 113.7 Cost = 100 Benefit/Cost Ratio = 1.137 (must be > 1)

Internal Rate of Return Definition: The interest rate that

results in a NPV = 0 Search for r = IRR such that: -100 = sum( 30/(1+r)^n) Interpretation: Earning 30 MUSD per

year is equivalent of having 100 MUSD on an account with interest rate of r

Here IRR = 15.2%

Relation of IRR to NPV

Interest Net PresentRate Value

0% 50.02% 41.44% 33.66% 26.48% 19.8

10% 13.712% 8.114% 3.016% -1.8 18% -6.2 20% -10.3

Net Present Value

0% 2% 4% 6% 8% 10%

Interest Rate

Comparison of investment alternatives Marginal Attractive Rate of Return

(MARR) Problems with uneven lifetimes Incremental Method

To every problem there exists a solution!

Marginal Attractive Rate of Return (MARR)

The lowest acceptable limit for IRR, i.e. IRR should be > MARR

MARR is determined by the best available alternative use of money

MARR can be IRR of best alternative investment possibility, or loan interest of the most expensive loan

Problems with uneven lifetimes

Determine lifetime (planning horizon) for each investment alternative

If uneven, use the shortest lifetime = Tmin in comparison

Estimate salvage value for other alternatives at end of Tmin and add to the cash flow

Incremental Method for Comparison

NPV measure: Select highest NPV Annual Worth: Same Pay Back Period: Not applicable IRR and B/C measures: Use

incremental method, i.e. calculate the difference

Determine if IRRdiff > MARR Determine if B/Cdiff > 1

Example of Incremental Method

InterestProject B: 10%

YearCash Flow Present Accum.n An: Value: NPV0 -150 -150.0 -150.01 42 38.2 -111.82 42 34.7 -77.13 42 31.6 -45.64 42 28.7 -16.95 42 26.1 9.2

Sum: 60 9.2Internal Rate of Return 12.4%

Difference B – A => IRR < MARR, so A is selected

Project B - A : 10%YearCash Flow Present Accum.

n An: Value: NPV0 -50 -50.0 -50.01 12 10.9 -39.12 12 9.9 -29.23 12 9.0 -20.24 12 8.2 -12.05 12 7.5 -4.5

Sum: 10 -4.5Internal Rate of Return 6.4%

We can´t always be choosy!

29 April 2015Project Evaluation1 1. Fundamentals Decision Making, Cost Theory, Break Even Analysis,...

Documents