Capital Budgeting: Financial Appraisal of Investment Projects

, by Don Dayananda , Richard Irons , Steve Harrison , John Herbohn , Patrick Rowland

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ISBN: 9780521520980 | 0521520983
Cover: Paperback
Copyright: 11/18/2002

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This book explains the financial appraisal of capital budgeting projects. The coverage extends from the development of basic concepts, principles and techniques to the application of them in increasingly complex and real-world situations. Identification and estimation (including forecasting) of cash flows, project appraisal formulae, and the application of net present value (NPV), internal rate of return (IRR) and other project evaluation criteria are illustrated with a variety of calculation examples. Risk analysis is extensively covered by the use of risk adjusted discount rate, certainty equivalent, sensitivity, simulation and Monte Carlo analysis. The NPV and IRR models are further applied to forestry, property and international investments. Resource constraints are introduced to the capital budgeting decisions with a variety of worked examples using linear programming technique. All calculations are extensively supported by Excel workbooks on the Web, and each chapter is well reviewed by end of chapter questions.

List of figures

xiii

List of tables

xiv

Preface

xvii

Capital budgeting: an overview

(11)

Study objectives

(1)

Shareholder wealth maximization and net present value

(1)

Classification of investment projects

(1)

The capital budgeting process

(4)

Organization of the book

(1)

Concluding comments

(1)

Review questions

(1)

Project cash flows

(25)

Study objectives

(1)

Essentials in cash flow identification

(1)

Example 2.1

(1)

Example 2.2

(7)

Asset expansion project cash flows

(4)

Example 2.3. The Delta Project

(4)

Asset replacement project cash flows

(1)

Example 2.4. the Repco Replacement Investment Project

(2)

Concluding comments

(1)

Review questions

(2)

Forecasting cash flows: quantitative techniques and routes

(18)

Study objectives

(1)

Quantitative techniques: forecasting with regression analysis; forecasting with time-trend projections; forecasting using smoothing models

(10)

More complex time series forecasting methods

(2)

Forecasting routes

(1)

Concluding comments

(1)

Review questions

(2)

Forecasting cash flows: qualitative or judgemental techniques

(19)

Study objectives

(1)

Obtaining information from individuals

(4)

Using groups to make forecasts

(4)

The Delphi technique applied to appraising forestry projects

(1)

Example 4.1. Appraising forestry projects involving new species

(1)

Example 4.2. Collecting data for forestry projects involving new planting systems

(3)

Scenario projection

(1)

Example 4.3. Using scenario projection to forecast demand

(1)

Concluding comments: which technique is best?

(2)

Review questions

(1)

Essential formulae in project appraisal

(17)

Study objectives

(1)

Symbols used

(1)

Rate of return

(1)

Example 5.1

(1)

Note on timing and timing symbols

(1)

Future value of a single sum

(1)

Example 5.2

(1)

Example 5.3

(1)

Present value of a single sum

(1)

Example 5.4

(1)

Example 5.5

(1)

Future value of a series of cash flows

(1)

Example 5.6

(1)

Present value of a series of cash flows

(1)

Example 5.7

(1)

Example 5.8

(1)

Present value when the discount rate varies

(1)

Example 5.9

(1)

Present value of an ordinary annuity

(1)

Example 5.10

(1)

Present value of a deferred annuity

(1)

Example 5.11

(1)

Example 5.12

(1)

Perpetuity

(1)

Net present value

(1)

Example 5.13

(1)

Net present value of an infinite chain

(1)

Internal rate of return

(1)

Example 5.14

(1)

Loan calculations

(1)

Example 5.15

(2)

Loan amortization schedule

(1)

Concluding comments

(1)

Review questions

(1)

Project analysis under certainty

(23)

Study objectives

(1)

Certainty Assumption

(1)

Net present value model

(2)

The net present value model applied

(1)

Other project appraisal methods

(1)

Suitability of different project evaluation techniques

(5)

Mutual exclusivity and project ranking

102

(6)

Asset replacement investment decisions

108

(1)

Project retirement

109

(2)

Concluding comments

111

(1)

Review questions

111

(3)

Project analysis under risk

114

(19)

Study objectives

115

(1)

The concepts of risk and uncertainty

115

(1)

Main elements of the RADR and CE techniques

116

(2)

The risk-adjusted discount rate method

118

(1)

Estimating the RADR

118

(1)

Estimating the RADR using the firm's cost of capital

119

(1)

Example 7.1. Computation of the WACC for Costor Company

120

(1)

Estimating the RADR using the CAPM

120

(6)

The certainty equivalent method

126

(1)

Example 7.2. Computing NPV using CE: Cecorp

127

(1)

The relationship between CE and RADR

128

(1)

Example 7.3. Ceradr Company investment project

128

(1)

Comparison of RADR and CE

129

(1)

Concluding comments

130

(1)

Review questions

130

(3)

Sensitivity and break-even analysis

133

(20)

Study objectives

133

(1)

Sensitivity analysis

134

(1)

Procedures in sensitivity analysis

135

(1)

Sensitivity analysis example: Delta Project

135

(3)

Developing pessimistic and optimistic forecasts

138

(3)

Pessimistic and optimistic forecasts of variable values for the Delta Project example

141

(3)

Applying the sensitivity tests

144

(1)

Sensitivity test results

145

(4)

Break-even analysis

149

(1)

Break-even analysis and decision-making

150

(1)

Concluding comments

150

(1)

Review questions

151

(2)

Simulation concepts and methods

153

(32)

Study objectives

154

(1)

What is simulation?

154

(2)

Elements of simulation models for capital budgeting

156

(2)

Steps in simulation modelling and experimentation

158

(4)

Risk analysis or Monte Carlo simulation

162

(1)

Example 9.1. Computer project

163

(8)

Design and development of a more complex simulation model

171

(1)

Example 9.2. FlyByNight project

171

(4)

Deterministic simulation of financial performance

175

(1)

Example 9.3. FlyByNight deterministic model

175

(2)

Stochastic simulation of financial performance

177

(1)

Example 9.4. FlyByNight stochastic simulation

177

(2)

Choice of experimental design

179

(1)

Advantages and disadvantages of simulation compared with other techniques in capital budgeting

179

(1)

Concluding comments

180

(1)

Review questions

180

(1)

Appendix:Generation of random variates

181

(4)

Case study in financial modelling and simulation of a forestry investment

185

(19)

Study objectives

185

(1)

Key parameters for forestry models

186

(1)

Sources of variability in forestry investment performance

187

(2)

Methods of allowing for risk in the evaluation of forestry investments

189

(1)

Problems faced in developing forestry financial models

190

(1)

Developing a financial model: a step-by-step approach

191

(1)

Example 10.1. Flores Venture Capital Ltd forestry project

192

(7)

Comparing forestry projects of different harvest rotations

199

(1)

Example 10.2. FVC Ltd: comparison of one-stage and two-stage harvest options

199

(1)

Risk analysis or Monte Carlo analysis

200

(1)

Example 10.3. Simulation analysis of FVC Ltd forestry project

200

(2)

Concluding comments

202

(1)

Review questions

203

(1)

Resource constraints and linear programming

204

(15)

Study objectives

206

(1)

LP with two decision variables and three constraints

206

(1)

Example 11.1. Roclap: product mix problem

206

(6)

Investment opportunities and by-product constraints

212

(1)

Example 11.2. Capital rationing problem

212

(2)

LP and project choice

214

(1)

Example 11.3. Project portfolio selection problem

215

(2)

Concluding comments

217

(1)

Review questions

217

(2)

More advanced linear programming concepts and methods

219

(17)

Study objectives

219

(1)

Basic LP assumptions and their implications for capital budgeting

220

(1)

Expanding the number of projects and constraints

221

(1)

Example 12.1. Power generator's decision problem

222

(2)

Indivisible investments and integer activity levels

224

(1)

Example 12.2. Resort development problem

225

(1)

Borrowing and capital transfers

226

(1)

Example 12.3. Borrowing and capital transfer problem

226

(2)

Contingent or dependent projects

228

(1)

Example 12.4. Infrastructure problem

228

(1)

Mutually exclusive projects

229

(1)

Example 12.5. Sports gear problem

230

(1)

Some other LP extensions for capital budgeting

231

(2)

Concluding comments

233

(1)

Review questions

234

(2)

Financial modelling case study in forestry project evaluation

236

(15)

Study objectives

237

(1)

Forestry evaluation models: uses and user groups

237

(1)

Financial models available to evaluate forestry investments

238

(1)

The Australian Cabinet Timbers Financial Model (ACTFM)

239

(7)

Review of model development and design options

246

(3)

Concluding comments

249

(1)

Review questions

250

(1)

Property investment analysis

251

(23)

Study objectives

252

(1)

Income-producing properties

252

(4)

Example 14.1. Property cash flows from the industrial property

256

(2)

Example 14.2. Equity cash flows before tax from the industrial property

258

(3)

Example 14.3. Equity cash flows after tax from the industrial property

261

(2)

Corporate real estate

263

(1)

Example 14.4. Acquiring the industrial property for operations

263

(3)

Example 14.5. Leasing or buying the industrial property for operations

266

(2)

Development feasibility

268

(1)

Example 14.6. Initial screening of an industrial building project

268

(2)

Example 14.7. Project cash flows from a property development

270

(1)

Example 14.8. Equity cash flows from the development project

271

(1)

Concluding comments

272

(1)

Review questions

272

(2)

Forecasting and analysing risks in property investments

274

(23)

Study objectives

275

(1)

Forecasting

275

(3)

Example 15.1. Forecasting operating cash flows for the industrial property

278

(5)

Example 15.2. Forecasting resale proceeds for the industrial property

283

(2)

Example 15.3. Forecasting development cash flows for a residential project

285

(3)

Risk analysis

288

(1)

Example 15.4. Net present value of the industrial property-sensitivity analysis

289

(1)

Example 15.5. Overbuilding for the industrial property-scenario analysis

290

(3)

Example 15.6. Development risks-Monte Carlo (risk) simulation

293

(1)

Concluding comments

293

(2)

Review questions

295

(2)

Multinational corporations and international project appraisal

297

(16)

Study objectives

298

(1)

Definition of selected terms used in the chapter

298

(1)

The parent's perspective versus the subsidiary's perspective

299

(2)

Example 16.1. Garment project

301

(2)

Exchange rate risk

303

(1)

Country risk

304

(1)

A strategy to reduce a project's exchange rate and country risks

305

(4)

Other country risk reduction measures

309

(1)

Incorporating exchange rate and country risk in project analysis

310

(1)

Concluding comments

311

(1)

Review questions

311

(2)

References

313

(3)

Index

316

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Capital Budgeting: Financial Appraisal of Investment Projects

Summary

Table of Contents

Supplemental Materials