Summary of all Financial Management lectures in the course Financial & Project Management. This course will be given in year 2 of Human Resource Studies (Personeelwetenschappen), Organization studies (Organisatiewetenschappen), and Global Management of Social Issues (GMSI).
In this summary, all le...
Samenvatting Basics of financial management PART 1
Business Economics 3 summary
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Tilburg University (UVT)
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Financial Project Management
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Lecture 1 FM
Capital budgetigg process of planning investment in assets, usually those whose returns are expected to extend
beyond one year.
Iivestmeit project / Capital budgetig projectg sum of all related investments in fxed and current assets.
Cash flow: diference between cash infows generated by sales and cash outlows related to the purchase of
resources related to these sales in a certain period.
Cash flowg
At start: Cash fow = -investments
During project: Cash fow = accountng income o depreciaton
- Accountng income = excess of revenues over costs
- Depreciaton = decrease in an asset’s value
Final year: Cash fow = accountng income o depreciaton o disinvestment value (residual value)i
Accountng income = net proft = proft afer tax
On the basis of cash fow taaing into account the tme value of moiey:
- Net present value (NPV)i
- Internal Rate of Return (IRR)i
Time valueg
Receive money today (1000 euros)i with 5% compound interest, then afer 4 years.
Future value = 1000*(1.05*1.05*1.05*1.05)i = 1215,51
Same amount of money (1000 euros)i received 4 years later:
Future value = 1000/(1.05^4)i = 822,70
Less!
Net Preseit Value (NPV)g present value of the expected cash fows, including the inital investment amount.
NPV = -investment o sum of future cash fows
- If NPV > 0 project merits further coisideratoi
- Discount rate is based on the weighted average cost of capital (WCC)i as interest rate.
- When for example NPV of project A is bigger than NPV of project B, then we prefer A
,Lecture 2 FM
Iiterial rate of returi (IRR)g discount rate where the NPV of a project equals zero.
If IRR > WAC (interest rate)i, project is acceptable
IRR can only be determined by trial and error or Excel
Example of calculatng IRR:
- IRR A (*€1,000)i: 0 = -500 o 150/(1oi)i o 200/(1oi)i^2 o 400/(1oi)i^3
i = 0.19
- IRR B (*€1.000)i: 0 = -300 o 100/(1oi)i o 100/(1oi)i^2 o 100/(1oi)i^3 o 200/(1oi)i^4
i = 0.21
- IRR of project B is bigger than IRR of project A. Both projects merit further consideraton
(both > WACC=8%)i. However, project B should be preferred if we only consider IRR.
NPV and IRR give contradictory results
NPV does not measure rate of return and NPV tends to favour projects with a longer duraton
IRR assumes that cash fows received before the end of the project can be invested during the remaining
period with a return equal to the IRR. For high IRRs, this is a dubious assumpton.
In practce: people may prioritie NPV (greater thai iero), and then consider IRR.
Disinvestment value should be added to the last year’s Cash fow!
Also when you calculate the NPV: include the disinvestment value for the last year’s cash fow amount that you
need in order to come to the NPV! Otherwise, the calculatons give a diferent amount.
Future cash fows are estmates
Seisitvity aialysisg analysis of the efect of change in sales on proft and cash fow.
Risk premiumg adding a risa premium to the discount rate.
Iiveitoryg ordering costs and carrying costs.
Creditg
Accounts receivable: credit given to customers (they owe you money)i
Account payable: money that you owe others
, Cashg money that is easily accessible, either via bana or in the business.
Why is Cash importait? Three motves.
1)i Transactonal motve safeguard contnuity of the producton process
2)i Precautonary motve cover random, unforeseen fuctuatons in cash in- and outlows
3)i Speculatve motve antcipate any asset price changes
See Worashop!
Maiagemeit Accouitig
Fixed costsg based on actual producton capacity; does not change in relaton to output level (depreciaton
costs)i.
Variable costsg change in direct relaton to the output level (wages, raw materials)i
Distncton between fxed and variable
Not clear-cut: depreciaton, or wages.
Depreciaton = fxed when depreciaton is caused by the passing of tme, but variable when caused by use.
Depends on tme horizon and relevant producton range
In long run, all costs are variable
Mixed costs: energy fee (fxed fee o usage)i
Cost-volume-proft aialysisg at a sales volume of the breaa-even quantty, the following applies:
Total reveiue = Total costs
Selliig price*break-evei sales volume = Fixed costs + (variable costs per uiit*break-evei sales volume)
Is the same as: p*q = F + v*q
(p – v)i = Contributon margin = (selling price – variable costs per unit)i
Contributon margin: increase in net income for each extra unit sold.
Can also be calculated given the turnover.
Rewritng the formula is important:
p*q = F + v*q
F = p*q – v*q
F = q(p-v)
P – v = coitributoi margii
Iidifereice poiitg level of producton volume at which, from a cost perspectve, it maaes no diference whether
an investment is made in a new producton technology or not.
Determined by relatng the iicrease in total fxed costs to the reductoi in variable costs per product.
In formule: Toename in Fixed costs/Afname in variable costs = aantal units
Aantal units * unit selling price = annual turnover
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