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Pertemuan III:

14 September 2013
KK ECA 206 Sie. A
Sabtu, 10.00 12.30

14 September 2013

Materi Pertemuan III

Chapter 8: Net Present Value and Other Investment

Capital Budgeting
Capital budgeting is the decision making
process for accepting or rejecting projects.
Chapter VIII develops the basic capital
budgeting methods. Practical application leave
to the chapter IX.
Fixed assets define the business of the firm.
Fixed asset investments are generally long
lived and not easily reversed once they are made.

Chapter VIII: Main Concepts

Net Present Value (NPV)
The payback rule
Payback period
Discounted payback period

The Average Accounting Return (AAR)

The Internal Rate of Return (IRR)
The Modified IRR (MIRR)

The Profitability Index (PI)

Theory: advantages and disadvantages, problems with each

Net Present Value (NPV)

NPV is the difference between an investments market value and its cost
Calculating NPV can using help by drawing timeline of project cash flows
consisting of four calculation

Initial costs
Cash Inflows (CIF)
Cash Outflows (COF)
Salvage value

NPV is the Present Value of those four calculation

Basic investment rule: Accept a project if NPV is greater than zero.
Attributes of NPV:
NPV uses cash flows, not earnings
NPV uses all the cash flow of the project.
NPV discounts the cash flow properly

The Payback Rule

Payback (period) is the amount of time
required for an investment to generate cash
flows sufficient to recover its initial cost.
An investment is acceptable if its calculated
payback period is less than some prespecified
number of years.

The Average Accounting Return

It is an investments average net income divided by
average book value.
Average net income consist of (Total COF + Total
CIF) divided by total number of periods
Average book value = (initial costs and end value)
divided by 2
A project is acceptable if its AAR exceeds target
average accounting return

The Internal Rate of Return

IRR is the discount rate that makes the NPV of an investment zero.
An investment is acceptable if the IRR exceeds the required return.
Problems with IRR:
Nonconventional Cash Flows
Mutually exclusive investments (crossover points)

The Modified Internal Rate of Return (MIRR)

The discounting approach (discount all negative CF back to the present at the
required return and add them to initial cost. Then, calculate the IRR. Because
the first modified cash flow is negative, there will be only one IRR. The
discount rate might be the required return.
The reinvestment approach (compound all cash flows positive and negative,
except the first out to the end of the projects life and calculate the IRR.
The combination approach (negative CF are discounted back to the present and
the positive CF are compounded to the end of the project)

The Profitability Index (PI)

PI is the present value of an investments
future cash flows divided by its initial cost.
Also, called the benefit cost ratio.
If a project has a positive NPV, then the PI
would be bigger than 1.00

21 September 2013