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There are four methods which we can use to evaluate the investments.
1) The Payback period
2) The accounting rate of return
3) The net present value method
4) The internal rate of return method
A. The Payback period;
The payback period is the number of years it takes to recover its initial investment. This method assists with the project risk and liquidity. The projects with the less payback period consider less risky than the projects with greater payback period.
Payback period = initial investment
Annual cash flow
B. The Accounting rate of return;
The accounting rate of return is
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The purpose of this paper is to explain the importance of net present value along with other investment criteria used in determining the value of business decisions regarding today’s investments for future returns. The paper will define what is meant by net present value and show how managers can use it as an analysis tool to decide if an investment is worth the calculated risk. Also, there will be three methods discussed that managers can use to propose the best financial projects to invest in to increase revenue for its owners. The methods discussed will include: the net present rule, the payback rule, and the internal rate of return. With each method there will be an explanation of
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careful evaluation you can than make your decision
based on the cash that can be paid out today to the firms investors. In essence, this is when the
valuation principle comes into play through analyzing the benefits and costs providing figures
that would help to make decisions based on the best alternative that would allow investors to
make a profit.
Describe how net present value is related to cost benefit analysis
Your net present value described as a series of cash flows which are both incoming and
outgoing. Your net value is the sum of the present values of the individual cash flows as with the
cost benefit analysis the benefits and costs are often displayed in terms of
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Internal Rate of Return (IRR) and Net Present Value (NPV) are both powerful tools used in business to determine whether or not to invest in a particular project; both methods have its pros and cons. If given a choice I would choose NPV, because of the potential to anticipate profitability.As it is assumed that the objective of a firm is to create as much shareholder wealth as possible for its owners through the efficient use of resources, the preferred method in determining whether or not to invest in a project is NPV. The reason for this is that NPV takes into account all the costs and benefits of an investment opportunity, making a logical allowance for the time factor. Generally speaking
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August 9, 2012
When it comes to capital investing many techniques can be used. Picking the right technique for a company can be a long draw out process. “Once a company purchases a capital asset, it is committed to that investment for an extended period of time” (Edwards, 2007). Guillermo Furniture wants to discover the technique will provide the greatest returns. There are two major capital investing techniques. One is net present value (NPV), and one is internal rate of return (IRR). “Managers can choose from among numerous analytical techniques to help them make capital investment decisions. Each technique has
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1. Assume that the before-tax required rate of return for Deer Valley is 14%. Compare the before-tax NPV of the new lift and advise the managers of Deer Valley about whether adding the lift will be profitable investment. Show calculations to support your answer.
We have to calculate the net present value of cash flows and compare this amount to the cost of investments.
Net present value of cash flows
(cash inflow – cash outflow) X the factor for PV of cash flows for ordinary annuity of $1 at 14% for 20 years, which is 6.6231 take from PV Table 1.
Additional skiers that the lift will allow x number of days per year when extra capacity will be needed x cost of lift
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CAPITAL BUDGETING DECISIONS
Prof.Dr. Anuj Verma
Understand the nature and importance of investment decisions Explain the methods of calculating net present value (NPV) and internal rate of return (IRR) Show the implications of net present value (NPV) and internal rate of return (IRR) Describe the non-DCF evaluation criteria: payback and accounting rate of return Illustrate the computation of the discounted payback Compare and contrast NPV and IRR and emphasize the superiority of NPV rule
Prof.Dr. Anuj Verma
Nature of Investment Decisions
The investment decisions of a firm are generally known as the capital budgeting
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from now the land will be worth 2.5 times what he paid for it.
Sell the property. A realty company has offered to purchase the property by paying $150,000 immediately and $23,000 per year for the next 16 years. Control of the property would go to the realty company immediately. To sell the property, Professor Ryatt would need to pay the mortgage off, which could be done by making a lump-sum payment of $71,000.
Professor Ryatt requires a 14% rate of return. Would you recommend he keep or sell the property? Show computations using the total-cost approach to net present value.
The net annual cash inflow from rental of the property would be:
|Net operating income
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1. The difference between the present value of an investment?s future cash ﬂows and its initial cost is the:
• net present value.
• internal rate of return.
• payback period.
• proﬁtability index.
• discounted payback period.
2. Which statement concerning the net present value (NPV) of an investment or a ﬁnancing project is correct?
• A ﬁnancing project should be accepted if, and only if, the NPV is exactly equal to zero.
• An investment project should be accepted only if the NPV is equal to the initial cash ﬂow.
• Any type of project should be accepted if the NPV is positive and rejected if it is negative.
• Any type of project with greater total cash inﬂows than total cash
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Sales: Year 1 Nil
Year 2 RM 10,000
Year 3 -6 RM 15,000
Fixed cost Year 1-6 RM 3,000
Variable cost 30% of sales
Investment RM 25,000
Terminal Value of InvestmentRM 5,000
Depreciation 10% of initial investment
Please prepare the Cash Flow Statement and estimate – (a) Payback Period; (b) Net Present Value (NPV) at 10% discount rate; and (c) Internal Rate of Return for the Project. Also prepare a Profit &Loss Statement and compute the average profit for the Project life.
Cash Flow Statement
Cash Flow Statement |
| RM |
| Year 1
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1. Net Present Value:
Net present value (NPV) is the difference between the present value of cash inflows and the present value of cash outflows. NPV compares the value of a dollar today to the value of that same dollar in the future, taking inflation and returns into account.
NPV is calculated using the following formula:
NPV= -C0 + C11+r+ C21+r2+…+ Ct(1+r)t
- C0 = initial investment
C = cash flow
r = discount rate
t = time
If the NPV of a prospective project is positive, the project should be accepted. However, if NPV is negative, the project should probably be rejected because cash flows will also be negative.
Example of Net Present Value
To provide an example of
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revenue; compute return on stockholders’ equity; average stock prices for each of the four years; and compute the ratio of price to book value for each of the four years.
SUN MICROSYSTEMS, INC.
Summary Consolidated Statement of Income (in millions)
2001 2000 1999 1998
Dollars Dollars Dollars Dollars
Net revenues . . . . . . . . . . . . . . . . . . . . . . . . . . $18,250 $15,721 $11,806 $9,862
Costs and expenses:
Cost of sales . . . . . . . . . . . . . . . . . . . . . . . . 10,041 7,549 5,670 4,713
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is generating for share holders. Ultimate goal of a company is to create value for shareholders. Thus, ROE is the right measure to find out if company is efficient in generating profit on its equity (and asset) or not.
However, ROE is not the absolute indicator of investment value. If value of shareholder's equity falls, ROE will go up. Similarly, if company is taking large write-down, ROE will fall sharply. Share buyback also lowers ROE while there is no change in company's operation. (McClure, 2010)
Internal Rate of Return (IRR) is an indicator of yield of an investment.IRR is widely used method in capital budgeting decisions. IRR is the discount rate where total present value of all
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Attached is the case study, some of the requirements and the calculations that I did. I am really uncertain how to solve the problem. I believe the problem in the case study is the following:
The company uses divisional hurdle rates in evaluating projects which could have a significant impact on the firm's financial and operating strategies. Increasing the hurdle rate decreases present value of a project. Since the project costs are fixed, changes in the value of inflows means changes in the net present value of the project. Therefore, if hurdle rates were to increase, Marriott's growth would decline as profitable projects no longer met the hurdle rates. On the other hand, if hurdle
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The company has a 30 tax rate and it uses the straight-line depreciation method.
Compute the net present value for each piece of equipment under each of the two
product lines. Which, if either, of these two investments is acceptable?
pg . ..j
3. |Product A ||Product B |
Sales ||$750,000 ||$600,000 |
Estimated costs: ||||||
Direct materials |$ 15,000 |||$ 8,000 ||
Direct labor |120,000 |||80,000 ||
Other cash operating ||||||
Expenses |30,000 |||25,000 ||
Depreciation* |500,000 |||300,000 ||
Total costs ||665,000 ||413,000 |
Income before taxes |||85,000 ||187,000 |
Income taxes (30) |||25,500
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activities for the firm is that cash flows from operating activities is a lot higher than net income. Adding back the depreciation of $230,000 and including accounts payable of $250,000 come into play. Whoever reads the statement of cash flows can see how much cash was made from day to day operations.
30. The buildup in plant and equipment has not been financed in a satisfactory manner because the plant and equipment has been financed by the increase in accounts payable. It would benefit the company if they did long term financing to go side by side with profits.
31. Book value per share (2009) --- (1,390,000 – 90,000) / 150,000 = $8.67
Book value per share (2010
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Year 4 $950,000
You have now been tasked with providing a recommendation for the project based on the results of a Net Present Value Analysis. Assuming that the required rate of return is 15% and the initial cost of the machine is $3,000,000.
1. What is the project’s IRR? (10 pts) 22%
1,100,000/ (1+0.15) ^1 = 1,100,000/1.15 = 956,521.74
1,450,000/ (1+0.15) ^2 = 1,450,000/1.3225 = 1,096,408.32
1,300,000/ (1+0.15) ^3 = 1,300,000/1.52087 = 85, 4771.10
950,000/ (1+0.15) ^4 = 950,000/1.74901 = $543,165.58
2. What is the project’s NPV? (15 pts)
NPV = 956,521.74 + 1,096,408.32 + 854,771.1 + 543,165.58 -3,000,000
577 words - 3 pages
Bill Miller and Value Trust
Value Trust has surpassed the S&P 500 by an average of 3.67% for the previous fifteen years. Value Trust also maintained Morningstar’s five star rating. Mutual fund investment performance can be measured by finding out its net asset value and Annual Total Return. Net Asset Value can be computed as the fund’s total assets minus the liabilities divided by funds shares outstanding. Annual total return can be measured by the increase or the decrease in net asset value plus the fund’s income distribution. These are used to find the measure of the percentage of annual growth rate of net asset value assuming that reinvestment, and the absolute dollar value today of
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. Considers the time value of money
2. Considers the riskiness of the project's
2. Requires an estimate of the cost of capital in
order to calculate the payback
cash flows (through the cost of capital)
3. Ignores cash flows beyond the discounted
Net Present Value
1. Tells whether the investment will
increase he firm's value
2. Considers all the cash flows
3. Considers the time value of money
4. Considers the risk of future cash flows
(through the cost of capital)
1. Requires an estimate of the cost of capital
in order to calculate the net present value.
2. Expressed in terms of dollars, not as a
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1. A best selling author decides to cash in on her latest novel by selling the rights to the book’s royalties for the next four years to an investor. Royalty payments arrive once per year, starting one year from now. In the first year, the author expects $400,000 in royalties, followed by $300,000, then $100,000 then $10,000 in the three subsequent years. If the investor purchasing the rights to royalties requires a return of 7 percent per year, what should the investor pay?
What the investor should pay is the present value of royalty payments. The discounting rate is given as 7%. We get
Year Royalty Payment (1) Discounting Factor (2) Present Value (1X2)
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considered impaired. There is no evidence of impairment in the present problem.) Thus, at December 31, 2013, the investment is reported at $168,000 (i.e., $12 x 14,000 shares purchased on January 1, 2013.).
(The following is not addressed in the problem. We are providing this discussion for completeness. Noncontrolling investments in marketable equity securities that also do not convey to the holder of the securities “significant influence” over the investee are reported in the balance sheet at fair value. If the securities are designated as “trading securities,” the change in fair value is reported in net income. If the securities are designated as “available for sale securities,” the
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methods for evaluating the capital investments of Johnson Controls in the emerging markets to reduce risk providing a rationale of how risk will be reduced.
Capital investments are evaluated by different methodologies depending upon the nature of risk and projects. There are three most popular traditional approaches to gauge the effectiveness of the investment. These approaches are; payback period, internal rate of return and net present value. Out of these approaches, NPV and IRR are the most popularly used by investors and companies (Weygandt, Kimmel & Kieso, 2012). With that said, a methodology that Johnson Controls could use to help in evaluating capital budget investments is net present
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The reason: The borrower is not required to pay the bond premium at the maturity date of the bonds. Thus, the bond premium is considered to be a reduction in the cost of borrowing.
9.How to determine the market value of a bond.
The current market price (present value) of a bond is a function of three factors:
1. the dollar amounts to be received,
2. the length of time until the amounts are received, and
3. the market rate of interest.
The process of finding the present value is referred to as discounting the future amounts.
PV= Future Value / 1(1+i
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Statement of the Problem
To determine if the proposed project by the controller of Diamond Chemicals is cost effective to the company by calculating key indicators - Payback Period (PBP), Cost Benefit Analysis, Present Value/Future Value (PV/FV), Net Present Value (NPV), Internal Rate of Return (IRR) and Return on Investment (ROI). Along with determining feasibility of the proposed project, we have to provide suggestions on the proposal by the assistant plant manager to include his EPC project as part of the current project, as the upper management rejected his expansion plan due to budget issues. Controller cannot include EPC project within the current project as it is a classic
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Measurement in Accounting: Attribute
Seminar Question 2
Property, plant & equipment Inventory Short-term equity investment
i. ii. iii. iv. Net present value (discounted net cash flow) Black-Sholes model Binomial model Others
Measurement in Accounting: Unit
Problems of Measurement in Accounting
Question 4: (Is aggregation (e.g. total assets) meaningful?)
Unit of measure?
Nominal $ Purchasing power
Mixed attributes, and Mixed unit of measure
Average Price-to-Book Ratio of the S&P 500 Companies, Dec 1977-Mar 2001 (Source: Lev 2001)
Seminar 2 Agenda
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) Due to population growth, demand is higher in the second period. Thus the marginal willingness to pay is given by P ’12 − 0.3q in later period. What would be the dynamically efficient allocation? (Use 10% discount rate). Compare your answer to the one from part a).
d) In addition to part c) also marginal cost is higher in the second period than in the first, due to the reserve depletions. The new marginal cost is given by MC ’ q.
What would be the dynamically efficient allocation in this case? Compare your answer with the one from part c).
a. From the condition previously mentioned, we know that dynamic efficiency is achieved if the present value of the marginal net benefits in
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to as the unlevered free cash flow because it is the cash flow before
interest on debt is considered.
We can reconcile the free cash flow to the firm with the free cash flow to equity by noting that the
difference between the two are:
Interest paid on debt, and
Net new debt financing.
In other words,
Free cash flow to the firm = FCFE + ⎡ interest (1-tax rate ) ⎤ ⎢ expense
Valuation using free cash flow
The valuation of a company requires discounting the future cash flow to the present. The cash flows that
we use in this valuation are forecasted free cash flows. The model that we use to determine a value
today depends on the assumptions
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Valuation and Capital Budgeting Part I, HEC-ULg 2013-2014 – Marie Lambert 5
• Compounding and discounting
Figure 4.8 – Ross, Westerfield and Jaffe, 8th ed., page 75
Valuation and Capital Budgeting Part I, HEC-ULg 2013-2014 – Marie Lambert
• Net present value criterion
Example – Ross, Westerfield and Jaffe, 8th ed., pg 92
Valuation and Capital Budgeting Part I, HEC-ULg 2013-2014 – Marie Lambert
Basics of capital budgeting
• Different issues need to be addressed - What do we need to value? We should evaluate the future cash flows that are generated from the asset that is being valued cash flows income or
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. When no such value can be added through the capital budgeting process and excess cash surplus exists and is not needed, then management is expected to pay out some or all of those surplus earnings in the form of cash dividends or to repurchase the company's stock through a share buyback program.
Choosing between capital budgeting projects may be based upon several inter-related criteria. (1) Corporate management seeks to maximize the value of the firm by investing in projects which yield a positive net present value when valued using an appropriate discount rate in consideration of risk. (2) These projects must also be financed appropriately. (3) If no positive NPV projects exist and
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, management can maximize its potential while limiting losses (Westerfield, Jaffe & Jordan, 2009).
Reason for Use
The theory of real options arose because of corporate dissatisfaction and those using capital budgeting techniques, because it was noted that discounted cash flows lacked in flexibility (Tong & Reuer, 2007).While the old-fashioned approaches are valued, and they do not take into account for the reality of the situation or the variations that could occur. Techniques such as discounted cash flow approaches and net present value method have proven to imprecisely represent the outcome of the investment because it does not allow for flexibility in the plan. Without real
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1. The net present value of Virginia’s assets is approximately $4.83 million dollars. This value was obtained from summing the $2 million Virginia receives today plus the present value of the $3 million she will receive exactly one year from now. These calculations are depicted in Table A. Thus, Virginia has approximately $4.83 million dollars at her disposal to spend and consume today if she pleases. This figure takes into account how much she could borrow today in order to have exactly $3 million to pay back one year from now, plus the original $2 million she receives today. Of course, if she consumes nothing today, she will have a greater amount to spend in exactly one year. If Virginia
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on the net profit of a business. Valuation procedures for inventory are different from cash, cash equivalents, temporary investments, and receivables. The aforementioned items consist of amounts or values that are easier to estimate as funds expected to be received from them. Conversely, inventory values disclosed on financial statements do not guarantee the expected amount of cash to be received in the future but the acquisition value of a cost expected to generate future revenues. Therefore, it is critical for a business to value inventory properly. Proper valuation considers the goods on hand, most reasonable cost flow assumption, and decline in market value of inventory after the
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Omega Health Foundation
Trinette M. Landry
October 11, 2010
Instructor: Moses Padilla
Omega Health Foundation
When doing a financial analysis of a business understanding the principles of finance and how, they relate to a certain company is important. Omega Health Foundation is a complex business with two hospitals, Omega and Able Memorial, plus a number of related medical service providers. All of the related entities are nonprofit with the exception of Omega Medical Management, INC (Cleverly & Cameron, 2007). Within this paper I will explain the principles of finance, compare and contrast net income and cash flow, compare and contrast market value and book value
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%, and 15.7% respectively. So, I use the average value, which is 18.7% as the anticipated tax rate for the future calculation because Google is a mature and stable company that its tax rate will not fluctuate significantly on an annually basis. In addition, the depreciation and capital expenditure given by Capital IQ are reasonable because they use the average margin from the previous three years values to predict future. The change in net working capital from year 2014 to 2018 are also reasonable and in a decreasing trend due to a decrease in income tax rate. By applying those values in the table, we can get the anticipated free cash flows over the next five years for Google (Appendix B). The
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budgeting deals with the investments in fixed assets, estimate expenditure, outflows and long term gains, and helps evaluate the adequacy of returns. First you must analyze the worth of each project and its return for the future. Some techniques that can be used to evaluate the project include, simple payback period, discounted payback period, net present value, internal rate or return, profitability index, and modified internal rate of return.
I have ranked the projects based on the following metrics I have listed above. Below, I have constructed a table with metrics you proved me and the rankings my rankings.
Metrics | Project A | Project B | Ranking |
Payback period (in years | 3.20
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fair value; this indicates a faithful and reliable representation.
iii. Inventories represent stock and their cost is stated at the lower of cost and net realisable value. The value of inventories includes a proportion of supply chain variable expenditure and transfers of gains or losses from equity that are related to inventories. The weighted average cost has been assigned to individual items. The Warehouse Group deal with the trade off between relevance and faithful representation by the use of net realisable value based on the estimated selling price during the course of normal business; less the estimated costs necessary to make the sale; this method insures relevancy.
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(enterprise) Value – Debt Value
r = discount rate, the cost of capital, or the required rate of return
DCF Valuation for Coca-Cola
In millions of dollars except per-share numbers. Required return for the firm is 9%. Actual cash flows
Cash from operations
- Cash investments (I)
Free cash flow
Discount rate (1.09)t
Present value of free cash flows
Total present value to 2004
Continuing Value (CV) *
Present value of CV
Book value of net debt
Value of equity (1999)
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% more than the two previous years.2000: (2,698/5,173) = .522 = 52.2%2001: (2,841/5,450 = .521 = 52.1%2002: (4,767/7,949) = .599 = 59.9%4. Net Income:2000: $614 million2001: $665 million2002: $458 millionWhen comparing the net income figures for the past three years, it is seen that between 2000 and 2001, the net income increased by $51 million, but between 2001 and 2002, the net income decreased by $207 million.5. A company's stock price is usually influenced by the amount of net income because when finding the price of the stock, you must divide the number of stocks by the net income. So, the higher the net income, the lower the price of stocks, which is what buyers look for (means better
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NPV = $12,391,304
b. After the announcement, the value of Stephenson will increase by $12,391,304, the net present value of the purchase. Under the efficient-market hypothesis, the market value of the firm’s equity will immediately rise to reflect the NPV of the project. Therefore, the market value of Stephenson’s equity after the announcement will be:
Equity value = $582,000,000 + 12,391,304
Equity value = $594,391,304
Market value balance sheet |
| Old assets | $582,000,000 | | | |
| NPV of project | 12,391,304 | | Equity | $594,391,304 |
| Total assets | $594,391,304 | | Debt & Equity | $594,391,304 |
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, internal rate of return, and net present value help to determine if the project is a good fit for the organization. Other important factors that must be considered are market analysis, and risk. Below, each of these important factors will be reviewed and a recommendation made in regards to the project proposed for Caledonia Products.
In the case of the proposed project, Caledonia Products focus should be firmly on that of cash flows. Principle number one of finance is that cash flow is what matters (Keown, Martin & Petty, 2012, p. 4). In other words, cash is king. While the accounting profits of projects or businesses are important, the importance of cash outweighs that. The ultimate reason
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asset is estimated in order to determine the extent of impairment. Recoverable amount is the higher of an assets net selling price and value in use. In assessing value in use, the estimated future cash flows expected from the continuing use of the asset and from its disposal are discounted to their present value using a pre-tax discount rate that reflects the current market assessments of time value of money and the risks specific to the asset. Reversal of impairment loss is recognised as income in the statement of profit and loss
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of bond face value | Outflow |
Contributed Capital | Issuance of stock for cash | Inflow |
| Repurchase of stock with cash | Outflow |
Retained Earnings | Payment of cash dividends | Outflow |
* Net increase (decrease) subtotal combines cash flows from operating, investing, and financing activities to produce an overall net change in cash.
* Net change in cash is added to the beginning cash balance to arrive at the ending cash balance, which is the same cash balance as reported on the balance sheet.
* Supplemental disclosure
* Noncash Investing and Financing Activities - in addition to their cash flows, all companies are required to report material investing and
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% 1.38 6.03% 17.25% 12.92%
Appendix 4 ‐Discounted Cash Flow(4) Calcualte the PV Perpetuity Growth Method WACC Unlevered Free Cash Flow Net Present Value of FCF Terminal growth rate Terminal value Present value of the terminal value Enterprise value Less net debt Equity value Equity value per share EBITDA Multiple Method WACC Unlevered Free Cash Flow Net prensent value of FCF Terminal multiple Terminal value Present value of the terminal value Enterprise value less Net debt Equity value Equity value per share
12.92% 33.90 $101.12
5% $449.43 $244.80 $345.92 ‐30 $315.92 $31.59
Implied EBITDA Terminal Multiple Terminal Year Free Cash Flow
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would be valued at the lower of its carrying value and fair value less cost to sell. In this case this means the cleaning equipment would be remeasured at its estimated selling price of $5,000, which is net of selling costs.
EXERCISE 4-13 (20-25 minutes)
|Calculation of net income: | |
| 2009 net income after tax |$43,000,000 |
| 2009 net income before tax | |
| [$43,000,000 ( (1 – .44
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the usefulness or depreciation of assets. There are 14 different items to include and fully support in your financial projections. With these different items it is best to give a month-by-month breakdown for the first year, a quarterly breakdown for the next two years, and an annual breakdown for the final two years you are projecting.
Financial projections has its purpose to show what the company is capable of realizing in revenues and profits. This are also used to develop a series of analysis that help make economic and financial judgements about the company’s potential - payback period, Net Present Value (NPV) and Internal Rate of Return (IRR).
Payback period helps the company see
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e) maintain steady growth in both sales and net earnings.
4. Accounting concepts for a ï¬rm to create value it must:
a) have a greater cash inï¬‚ow from its stockholders than its outï¬‚ow to them.
b) create more cash ï¬‚ow than it uses.
c) reduce its investment in ï¬xed assets since ï¬xed assets require the use of cash.
d) avoid payments to the government so dividends can be increased.
e) avoid the issuance of debt securities
Find the week 1 connect problems answers here FIN 571 Week 1 Connect Problems
5. The primary goal of ï¬nancial management is to:
a) maximize current dividends per share of the existing stock.
b) maximize the current value per share of the