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CFA Corporate Finance session covers the principles that corporations use to make their investing and financing decisions. Capital budgeting is the process of making decisions about which long-term projects the corporation should accept for investment and which it should reject. Both the expected return of a project and the financing cost should be taken into account.
2. Net Present Value (NPV)
- CF0 CF1 CF2 CF3
0 1 2 3
where
CF0 = the initial investment
PV = - CF0 outlay
CFt = after tax cash flow at
PV = CF1/(1+k)1 time t
k =required rate of return for
PV = CF2/(1+k)2 project
PV = CF3/(1+k)3
Sum of all this is
NPV IF…… DECISION
NPV > 0 The project may be accepted.
NPV decision rule:
NPV < 0 The project should be rejected.
NPV = 0 The Company is indifferent in accepting or rejecting the
project. The project does not add any value to shareholder.
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3. Concept Checker
Project A Project B
Year CFAT Year CFAT
1 12,000 1 22,000
2 14,000 2 20,000
3 16,000 3 16,000
4 20,000 4 14,000
5 22,000 5 12,000
Cash Flows 84,000 84,000
Initial Investment – 60,000
After tax Cost of Capital is 10%
NPV ? ?
A. 1320.10 & 5429
B. 1240.20 & 5563.20
C. 1820.91 & 5563.20
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4. Answer
C
Calculating NPV with the BA II PLUS professional calculator from Texas Instruments.
Project A Key Strokes Explanation Display
[CF] [2nd] [CLR Work] Clear memory registers CFO = 0.0000
60,000 [+/-] [Enter] Initial Investment (Cash outflow) CFO = - 60,000.0000
[ ] 12,000 [Enter] Period 1 cash flow CO1 = 12,000.0000
[ ] Frequency of cash flow 1 F01 = 1.0000
[ ] 14000 [Enter] Period 2 cash flow CO2 = 14,000.0000
[ ] Frequency of cash flow 2 F02 = 1.0000
[ ] 16,000 [Enter] Period 3 cash flow CO3 = 16,000.0000
[ ] Frequency of cash flow 3 F03 = 1.0000
[ ] 20,000 [Enter] Period 4 cash flow CO4 = 20,000.0000
[ ] Frequency of cash flow 4 F04 = 1.0000
[ ] 22,000 [Enter] Period 5 cash flow CO5 = 22,000.0000
[ ] Frequency of cash flow 5 F05 = 1.0000
[NPV] 10 [Enter] 10% discount rate I = 10.0000
[ ] [CPT] Calculate NPV NPV = 1820.91
Cont
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5. Cont……
Project B – NPV for project B can be calculated in the same fashion as calculated for
Project A.
NPV
Project A 1820.91
Project B 5563.20
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