Describe the internal rate of return criterion and its strengths and weaknesses. Recognize why the net present value criterion is the best way to evaluate proposed investments. Calculate the profitability index and understand its relation to net present value.

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 Capital Budgeting

Goals

After completing this module, you will be able to do the following:

  • Outline the facts of the payback rule and some of its shortcomings.
  • Accounting rates of return and some of the problems with them.
  • Describe the internal rate of return criterion and its strengths and weaknesses.
  • Recognize why the net present value criterion is the best way to evaluate proposed investments.
  • Calculate the profitability index and understand its relation to net present value.
  • Interpreting how to determine the relevant cash flows for a proposed investment
  • Understand how to analyze a project’s projected cash flows.
  • Practice how to evaluate an estimated NPV.

Overview

The process of allocating, or budgeting, capital is usually more involved than just deciding whether or not to buy a particular fixed asset. We frequently face broader issues like whether or not we should launch a new product or enter a new market. Decisions such as these determine the nature of a firm’s operations and products for years to come.

For these reasons, the capital budgeting question is probably the most important issue in corporate finance. How a firm chooses to finance its operations, (the capital structure question) and how a firm manages its short-term operating activities (the working capital question) are certainly issues of concern, but it is the fixed assets that define the business of the firm.

So far, we’ve covered various parts of the capital budgeting decision. Our task in this module is to start bringing these pieces together. In particular, we show you how to “spread the numbers” for a proposed investment or project and, based on those numbers, make an initial assessment about whether or not the project should be undertaken.

In the discussion that follows, we focus on the process of setting up a discounted cash flow analysis. We know that the projected future cash flows are the key element in such an evaluation. Accordingly, we emphasize working with financial and accounting information to come up with these figures.

This module covers the different criteria used to evaluate proposed investments. The six criteria, in the order in which we described them in this module are:

– Net present value (NPV)

– Payback period

– Average accounting return (AAR)

– Internal rate of return (IRR)

– Modified internal rate of return, and

– Profitability index (PI)

We illustrate how to calculate each of these and outline the interpretation of the results. We also describe the advantages and disadvantages of each of them. Ultimately, a good capital budgeting criterion must tell us two things. First, is a particular project a good investment? Second, if we have more than one good project, but we can only take one this criterion can always provide the correct answer to both questions.

Finally, we appraise how to go about putting together a discounted cash flow analysis and evaluating the results; for example,

– The identification of relevant project cash flows. We discuss project cash flows and describe how to handle some issues that often come up, including sunk costs, opportunity costs, financing costs, net working capital, and erosion.

– Preparing and using pro forma, or projected financial statements. We show how pro forma financial statement information is useful in coming up with projected cash flows.

– The use of scenario and sensitivity analysis. These tools are widely used to evaluate the impact of assumptions made about future cash flows and NPV estimates.

Read: Essentials of Corporate Finance: Chapters 8 and 9

 

 

 

 

 

 

 

 

 

 

Assignment

 

Discussion Question:

NPV Valuation. The Yurdone Corporation wants to set up a private cemetery business. According to the CFO, Barry M. Deep, business is “looking up.” As a result, the cemetery project will provide a net cash inflow of $109,000 for the firm during the first year, and the cash flows are projected to grow at a rate of 5.1 percent per year forever. The project requires an initial investment of $1,425,000.

  1. If Yurdone requires a return of 12 percent on such undertakings, should the cemetery business be started?
  2. The company is somewhat unsure about the assumption of a 5.1 percent growth rate in its cash flows. At what constant growth rate would the company just break even if it still required a return of 12 percent on its investment?

 

Make a list of three services provided by your town/city and three provided by your state that directly benefit you. After thinking about how you directly pay for these do you believe you get your money’s worth?

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Stabilize, Distribute & Allocate

Some surveys show that citizens are quite aware of services provided by local governments but often not very certain about what is provided by state governments.  Make a list of three services provided by your town/city and three provided by your state that directly benefit you.  After thinking about how you directly pay for these do you believe you get your money’s worth?

How long would this coronavirus pandemic last? Would the general public be eager to resume traveling once the shutdowns were eased, or would consumer demand for commercial travel return slowly? Have Southwest’s management team done a good enough job navigating the crisis so far, or have they led investors astray?

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WK 1

It was April 15, 2020, and Berkshire Hathaway CEO Warren Buffett, colloquially known as the “Oracle of Omaha,” was sitting in his office in downtown Omaha, Nebraska. He had been discussing with his Berkshire partner Charlie Munger the status of his investment in Southwest Airlines. 1 Berkshire Hathaway currently owned a 10.3% stake in Southwest (Isidore, 2020), the world’s largest low-cost airline carrier. The coronavirus pandemic sweeping the world was decimating the revenues for airlines on a global basis, and Buffett was concerned about the aviation industry’s future. Since the pandemic began, people had been avoiding air travel vigorously due to guidance from health authorities amid virus fears, and the last week of March had seen a 55% decline in commercial flights compared to the same week in 2019 (Weber, 2020). Buffett was virtually hosting the annual shareholders meeting for Berkshire Hathaway in a couple of weeks, and the airline industry was sure to be a topic of conversation due to its recent financial troubles. Should Buffett hang on to his stake in Southwest, and perhaps buy even more shares due to the heavily decreased stock price? Or should he divest his stake in Southwest and cut his losses? He had a big decision to make, and it was surely one that Berkshire’s investors would be keenly listening to.

https://sk-sagepub-com.ezproxy.umgc.edu/cases/the-oracle-of-omaha-liftoff-or-crash-landing

First, read the case The Oracle of Omaha: Liftoff or Crash Landing?

Second, answer the questions below. In your initial response to the topic you have to answer all questions:

1. How long would this coronavirus pandemic last? Would the general public be eager to resume traveling once the shutdowns were eased, or would consumer demand for commercial travel return slowly?
2. Have Southwest’s management team done a good enough job navigating the crisis so far, or have they led investors astray?
3. What is the long-term outlook for the airline industry, and how will its financial metrics look post-shutdown? Some metrics to focus on include total passengers, total revenue, and stock price.
4. In April 2020, should Buffett sell his shares in Southwest Airlines or buy further stock at the new reduced price?

Critically analyse the benefits and limitations of cryptocurrencies on the financial world. Highlight the critical concepts in cryptocurrencies that affect their operations and use in the financial sector. Analyse the impact of cryptocurrencies on the financial and money markets.

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Cryptocurrency and How It Affects the Financial World

Introduction

Background

Cryptocurrency is a virtual or digital currency usually secured using cryptography to make it almost impossible to double-spend or counterfeit. It is a digital asset based on a system that allows for its distribution across many computers (Kirkby, 2018). Most cryptocurrencies operate under decentralised systems based on Blockchain technology, defined as a form of distributed ledger enforceable by a distinct network of computers (Furneaux, 2018). A critical characteristic of cryptocurrencies is that they are usually not issued by any dominant authority, thus rendering them hypothetically immune to manipulation or government interference (Nica et al., 2017). Cryptocurrencies can be obtained by being purchased from cryptocurrency exchanges or mined. However, not all e-commerce businesses and websites accept payments using cryptocurrencies despite their increasing popularity (Lee, 2022). Bitcoin has emerged to be the trendsetter in cryptocurrencies, ushering in a wave of other cryptocurrencies pegged on a decentralised peer-to-peer network (Tapscott and Tapscott, 2018). It continues to lead in cryptocurrencies in terms of popularity, market capitalisation, and user base. Besides Bitcoin, other types of cryptocurrencies include Ethereum (ETH), Litecoin (LTC), Cardano (ADA), Ripple (XRP), Polkadot (DOT), Dogecoin (DOGE), Stellar (XLM), Binance Coin (BNB), Monero (XMR), and Tether (SDT) among others. Each cryptocurrency is considered to have different specifications and functions (Garcia and Garcia, 2019). For example, banks use Ripple’s XRP to facilitate transfers in other geographic locations.

Importance of the Topic

The rapid growth and advancement in science and technology, especially in the financial sector, has led to recent breakthroughs and the adoption of new Fintech, such as cryptocurrencies (Zhao, 2021). Cryptocurrencies have significantly reduced the level of dependence on financial intermediaries leading to the spontaneous growth of the digital economy. The ideals of decentralisation that cryptocurrencies carry contribute a lot to their popularity; nonetheless, their volatility increases their risks (Campbell-Verduyn, 2018). Cryptocurrencies offer several incentives to entrepreneurs globally, and it has facilitated their reach to the international markets instead of remaining in the national markets. Investors have been able to form connections in addition to developing trust with markets that were initially not accessible (Krasilnikov, 2018). Although the uptake of cryptocurrencies is expanding steadily and gaining popularity in the financial sector, traditional financial institutions, including commercial banks, are hesitant to adopt these digital assets (Aljosha et al., 2017). This is based on the shallow understanding that their inherent risks override their potential advantages. However, developing a thorough comprehension of these digital currencies among traditional financial systems and their clients will change their general perception leading to a positive drive towards a new era of efficiency and innovation (Grabowski, 2019). This essay will undertake a critical review of the literature to develop an understanding of cryptocurrency and its effects on the financial world using a wide range of associated sub-themes such as origin, essential concepts, operations, legality, impact on economic and money markets, and the benefits and limitations of cryptocurrencies. The paper will highlight how cryptocurrencies impacted the financial world during the COVID-19 pandemic. The topic of the essay further demonstrates its importance by seeking to debunk myths and misunderstandings that reduced the uptake of cryptocurrencies.

Objectives of the Essay

This essay seeks to address the following objectives:

  1. To critically analyse the benefits and limitations of cryptocurrencies on the financial world.
  2. To highlight the critical concepts in cryptocurrencies that affect their operations and use in the financial sector.
  3. To analyse the impact of cryptocurrencies on the financial and money markets.

Who are the most significant (strongest) competitors? How is the company positioned in the industry? What resources, capabilities, and core competencies greatly benefit the company? In what areas is the company potentially weak or requires managerial attention? What is your overall conclusion regarding your company’s current operations?

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Prompt: Submit the second draft for the case study on topics five through nine (listed below).

Who are the most significant (strongest) competitors? How is the company positioned in the industry?

Strategy? Products/services? Innovation? Targeted customers? Demand? Global? Competitive advantages/disadvantages? What resources, capabilities, and core competencies greatly benefit the company? In what areas is the company potentially weak or requires managerial attention? What is your overall conclusion regarding your company’s current operations?

Financial strengths and weaknesses? Performance? PM? Operating margin? Leverage? ROE? Stock price? Expected growth in revenues and net profit?

Acquisitions/mergers? Alliances with other companies?

Any major economic issues impacting the company? Oil prices? Trade? Inflation? Interest rates? Tensions among countries?

How much does your company have in bonds issued? What types of bonds do have they issued? When are some of the amounts due to reach maturity? What is the rating of their most recent bonds?

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COMPANY: NIKE INC.

Corporate bonds is one category of debt ssued by a company and sold to investors. The investors are basically lenders to the company – bonds are contractual debt. With bonds, the company gets capital to buy additional assets and in return the bond holder is paid interest payments at either a fixed or variable interest rate. When the bond expires, or “reaches maturity,” the payments cease and the original investment is returned. For your company, review the 10-K report and analyze their bond issuances.

Discussion questions for NIKE INC.

1. How much does your company have in bonds issued? What types of bonds do have they issued? When are some of the amounts due to reach maturity?

2. What is the rating of their most recent bonds?

3. If interest rates are rising, how does this impact the yield of the current bond holders

Analyze and evaluate a business’s financial health and recommend the best financing options for the business to choose in order to improve its current financial health.

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Project Two assignment

Prompt
Write a brief journal introducing the business you chose for your Project Two assignment.
In Project Two, you will analyze and evaluate a business’s financial health and recommend the best financing options for the business to choose in order to improve its current financial health. Use will use Tesla as an example. Then locate the most recent quarterly financial statements for the business: the balance sheet, the income statement, and the cash flow statement.

In order to succeed in your Project Two assignment, you will need to understand the role of financial statements and how they help businesses determine their current financial health. You will also need to describe why cash flow management is important to a business and that business’s

Discuss three practical considerations that would guide you through selecting an optimal capital structure for your firm. Rank these considerations from the most important to the least important. Explain why you chose this ranking.

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8-1 Case Study Four: Weighted Average Cost of Capital

Discuss three practical considerations that would guide you through selecting an optimal capital structure for your firm. Rank these considerations from the most important to the least important. Explain why you chose this ranking.

 

When God blesses us financially, what does He expect us to do with the abundance? Why might the revenue and cost figures shown on a standard income statement not be representative of the actual cash inflows and outflows that occurred during a period?

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IDK

Answer the three questions (your response should be a minimum of 150 words), and submit answers to the problems.

When God blesses us financially, what does He expect us to do with the abundance?

Why might the revenue and cost figures shown on a standard income statement not be representative of the actual cash inflows and outflows that occurred during a period?

Discuss some of the uses and limitations associated with performing ratio analysis.

Critically analyse different methods for business owners to legally limit their exposure to taxation. Use real industry examples as part of the evaluation and comparison.

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Taxation is an important consideration for all businesses.

Critically analyse different methods for business owners to legally limit their exposure to taxation.

Use real industry examples as part of the evaluation and comparison.

This essay could include short sections on
a) differences in rates between Scotland and England
b) how dividends can be taken to be a tax efficient method of renumeration
c) national insurance contributions – a knowledge of main rates and an understanding of the effects of employer’s contribution on the profit and loss account
d) corporation tax – knowledge of rates and an appreciation of the benefit of wages in reducing corporation tax as opposed to dividends
e) Gifts and inheritance tax
f) Annual Investment Allowances
g) Writing Down Allowances
h) Capital allowances for energy-efficient technology
i) Research and Development