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![Page 1: tilkommer](https://reader033.fdocuments.us/reader033/viewer/2022051411/5459b31caf79594f558b5795/html5/thumbnails/1.jpg)
FARM MANAGEMENT
WK 5: CAPITAL BUDGETS
(INVESTMENT ANALYSIS)
MM WATERLOO
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Farm Mtg Concepts
Wk 1: Introduction
Wk 2: Economics & Farm Records
Wk 3: Budgets
Wk 4: Whole Farm Budgets
WK 5: CAPITAL BUDGETSWk 6: Machinery Management
Wk 7: Land Management
Wk 8: Credit Management
Wk 9: Human Resource Management
Wk 10: Estate Planning
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Discussion PointsI. IntroductionII. Capital Budget StepsIII. Non-time Methods A. Payback B. Acct Rate Of Return
C. Book Rate Of ReturnIV. Summary
Wk 5: Capital Budgets
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I. Introduction
A. Definition: Allocation Of Resources For Major And/Or Long Term Projects
B. Assumptions
1. Unlimited Projects
2. Limited Resources
Wk 5: Capital Budgets
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C. Types Of Investment Choices
2. Preference: Which Is Best
1. Screening: Which Are
Good
Wk 5: Capital Budgets
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D. Basis Of Decisions
A. Style, “Paint Color”B. Prestige, Image
A. Profitability B. Rate Of Return
2. Quantitative: “Will It Pay”
1. Qualitative: “What I Want”
Wk 5: Capital Budgets
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II. Capital Budget StepsA. Determine Cost Of Capital
Aft Tx Rate: Int Rate*(1-tx Rate)
+ Inflation Rate
+ Risk Factor
= Cost Of Capital
B. Determine Initial Investment
C. Determine Net Cash Flows
Net Cash = Cash Rec- Cash Exp
D. Estimate Terminal Value
E. Calculate Investment Measures
Wk 5: Capital Budgets
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III. Non-time MethodsA. Payback 1. Advantages A. Simple & Easy B. Widely Used C. Emphasizes Liquidity 2. Disadvantages A. Profitability Not Considered B. Cash Flows After Payback Are Ignored C. Time Value Of Money Ignored
WK 5: Capital Budgets
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3. Pay Back Calculation
Investment
Cash Flow 1
Cash Flow 2
Cash Flow 3
Cash Flow 4
Cash Flow 5
Salvage Val
Tot Revenue
Profit
Payback
Lump
$10,000
$0
$0
$0
$0
$15,000
Equal
$48,000
$10,000
$10,000
$10,000
$10,000
$10,000
Unequal
$4,000
$2,000
$2,000
$3,000
$15,000 $50,000 $7000$5,000 $2,000 $3,0004.66 Yr 4.8 Yr 2.0 Yr
$0 $0 $0
WK 5: Capital Budgets
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B. Acct Rate Of Ret & Book Rate
1. Advantages
A. Calculation Ease
B. Good For Screening
C. Gd For Short Life Projects
2. Disadvantages
A. Time Val Of $ Not Considered
B. Doesn’t Consider The Timing
Of The Flows
WK 5: Capital Budgets
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3. Acct Rate Of Ret Calculation
Investment
Cash Flow 1
Cash Flow 2
Cash Flow 3
Cash Flow 4
Cash Flow 5
Salvage Val
Lump
$10,000
$0
$0
$0
$0
$15,000
Cash-Invest
Time
========== >
Investment
15,000-10,000
5
========= >
10,000
5,000
5
==== >
10,000
1000
==== >
10,000
= 10%
$0
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Investment
Cash Flow 1
Cash Flow 2
Cash Flow 3
Cash Flow 4
Cash Flow 5
Salvage Val
Equal
Cash-Invest
Time
========== >
Investment
50,000-48,000
5
========= >
48,000
2,000
5
==== >
48,000
400
==== >
48,000
= .8%
$48,000$10,000
$10,000
$10,000
$10,000$10,000
$0
WK 5: Capital Budgets
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Investment
Cash Flow 1
Cash Flow 2
Cash Flow 3
Cash Flow 4
Cash Flow 5
Salvage Val
Unequal
Cash-invest
Time
========== >
Investment
7,000-4,000
3
========= >
4,000
3,000
3
==== >
4,000
1,000
==== >
4,000
= 25%
$4,000$2,000$2,000
$3,000
$0
WK 5: Capital Budgets
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4. Book Rate Of Ret Calculation
Investment
Cash Flow 1
Cash Flow 2
Cash Flow 3
Cash Flow 4
Cash Flow 5
Salvage Val
Lump
Cash-Invest
No Of Flows
Invest + Salv
2
15,000-10,000
5
========= >
5,000
5,000
5
==== >
5,000
1000
==== >
5,000
= 20%
$10,000
$0
$0
$0
$0
$15,000
$0
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Investment
Cash Flow 1
Cash Flow 2
Cash Flow 3
Cash Flow 4
Cash Flow 5
Salvage Val
Equal
50,000-48,000
5
========= >
24,000
2,000
5
==== >
24,000
400
==== >
24,000
= 1.6%
Cash-Invest
No Of Flows==========================
Invest + Salv
2
48,000
10,000
10,00010,000
10,000
10,000
$0
WK 5: Capital Budgets
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Investment
Cash Flow 1
Cash Flow 2
Cash Flow 3
Cash Flow 4
Cash Flow 5
Salvage Val
Unequal
7,000-4,000
3
========= >
2,000
3,000
3
==== >
2,000
1,000
==== >
2,000
= 50%
Cash-Invest
No Of Flows========================
Invest + Salv
2
$4,000$2,000$2,000$3,000
$0
WK 5: Capital Budgets
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Non-time Summary
Tot Rev
Profit
Payback
Acct Rate
Book Rate
Lump Equal Unequal
$50,000 $20,000 $7,000
$5,000 $2,000 $3,000
4.66 Yr 4.8 Yr 2.0 Yr
10% .8% 25%
20% 1.6% 50%
WK 5: Capital Budgets
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IV. Time Value Of Money
A. Future Value
WK 5: Capital Budgets
1 ...Of A Lump Sum
(Compounding) Looking Ahead
2 ...Of An Annuity (Regular Deposits)B. Present Value Looking Now
1 ...Of A Lump Sum
(Discounting)
2 ...Of An Annuity (Regular Deposits)
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IV. Time Value Of Money
Year 1: $100 * .10 * 1 Yr = $110.00
Year 2: $110 * .10 * 1yr = $121.00
Year 3: $121 * .10 * 1 Yr = $133.10
Lump Sum
Investment
$100
1st YR INTEREST
10% * 100 = $10
2nd YR INTEREST
10% *(100+10) = $11
3rd YR INTEREST
10% *(100+10+11)=12
A. Future Value (Compounding) 1. ...Of A Lump Sum
FUT VAL = LUMP Sum*(1+i)n
=$100 *(1+.10)3
= $133.00
WK 5: Capital Budgets
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2. …Of A Yr End Annuity 2. …Of A Yr End Annuity END 1st YR; $100 * (1+ .1)2 = $121.00 END OF 3rd YR
END 2nd YR; $100 * (1 + .1)1 = $110.00 END OF 3rd YR
END 3rd YR; $100 * (1 + .1)0 = $100.00 END OF 3rd YR
$331.00
$331
Yr 1
Invest
$100
Yr 2 Int
$10
Yr 3 Int
$11
Yr 2
Invest
$100
Yr 3
Invest
$100
Yr 3 Int
$10
=
FUT VAL = INV STREAM*(1 + I)n -1
I
WK 5: Capital Budgets
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B. Present Value (Discounting)(Discounting) 1. ... Of A Future Lump SumOf A Future Lump SumPres Val (@10%) Of $ 100 Received 3 Yr From Now?
Pres Val = Future Value *[ 1/((1+.1)n)]
Pres Val = 100 *[1/(1 + .1)3] = $75.13
Proof: $75.13*(1 + .1)3 = $99.998
$ ?
Lump
Sum
$82.60
$100
Future Value
In
3 Yrs$75.13
$90.01$8.31$7.47
$9.09
WK 5: Capital Budgets
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2. .... Of An Investment Stream2. .... Of An Investment StreamEND 1st YR; $100 * .909 = $90.90 (Pres Val)
END 2nd YR; $100 * .826 = $82.60 (Pres Val)
END 3rd YR; $100 * .751 = $75.10 (Pres Val)
$248.60
$248.60 Is Max To Pay For Invest That Pays $100/Yr Annuity @ 10% Interest
PRES VAL = INV STRM*[1-(1 + I)-n ]/I
$75.13
Pres
Val
$82.60
Pres
Val
$90.91
Pres Val
$9.09
$7.47
$8.31
$9.09
$8.31
$9.09$248.60
$75.13
+
82.60
+
$90.91
Present Value At 10% To
Give $100 A Yr For 3 Yrs
=
WK 5: Capital Budgets
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IV. Present Value MethodsA. Net Present Val & Benefit/Cost
1. Advantages
A. Considers Time Val Of $
B. Focus On Cash Flows
2. Disadvantages
A. More Complex Calculations
B. Assumes Reinvestment At
Rate Of Return
WK 5: Capital Budgets
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B. Net Present Val Calculation
Investment
Cash Flow 1
Cash Flow 2
Cash Flow 3
Cash Flow 4
Cash Flow 5
Salvage Val
Lump
$10,000Table 2:
10%
Present Value
-Investment
Net Present Value
Pres Val
$9,315
0.9090.826
0.751
0.683
$0$0
$0
$0
$15,000
$0
$0
$0$0
0.621 9,315
(685)
-10,000
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Investment
Cash Flow 1
Cash Flow 2
Cash Flow 3
Cash Flow 4
Cash Flow 5
Salvage Val
Equal
$48,000
$10,000
$10,000
$10,000
$10,000
$10,000
Table 2: 10%
Present Value
-Investment
Net Present Value
Pres Val
9,090
8,260
7,510
6,830
6,210
37900
$37,900
-$48,000
($10,100)
0.621
[3.790]
0.683
0.751
0.8260.909
WK 5: Capital Budgets
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Investment
Cash Flow 1
Cash Flow 2
Cash Flow 3
Cash Flow 4
Cash Flow 5
Salvage Val
Unequal
$4,000
$2,000
$2,000
$3,000
Table 2: 10%
0.909
0.826
0.751
Present Value
-Investment
Net Present Value
Pres Val
1,818
1,652
2,253
5,723
$5,723
-$4,000
$1,723
WK 5: Capital Budgets
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B. Benefit- Cost Calculation
Investment
Cash Flow 1
Cash Flow 2
Cash Flow 3
Cash Flow 4
Cash Flow 5
Salvage Val
Lump
$10,000
$0
$0
$0
$0
$15,000
Equal
$48,000
$10,000
$10.000
$10,000
$10,000
$10,000
Present Value
Investment
Benefit/Cost =
Unequal
$4,000
$2,000
$2,000
$3,000
9,315
10,000
37,900
48,000
5,723
4,000
1.43 .790 .932
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1. Advantages
A. Considers All Cash Flows
B. Provides Base For Comparison
2. Disadvantage
A. Most Complex
B. Assumes Reinvestment At
Internal Rate Of Return
B. Internal Rate Of Return
WK 5: Capital Budgets
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3. Internal Rate Of Ret
1. Use Payback Period
2. Find Approp Row In Table1
3. Go Across To Find Payback
4. Read Up To Find % Ret
Lump
4.66
5 Yr
X.X - X.X%
3 - 4 %
Equal
4.8
5 Yr
X.X- X.X%
3 - 4%
Unequal
2.0
5 Yr
X.X - X.X%
3- 4%
WK 5: Capital Budgets
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Time Summary
Net Pres Value
Benefit Cost
Internal
Rate
Lump Equal Unequal
$-685 $-10,100 $1,723
.932 .790 1.43
Xx% % %
WK 5: Capital Budgets
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Summary1. Capital Budgeting Looks At The
Profitability Of Lg. Investments
2. Results Of “Non-time” Methods ( Payback, Acct Rate Of Ret, & Book Rate Of Return) Can Not Be Compared To Bank Rates.
3.Results Of “Time” Methods (Net Present Val, Benefit-cost, & Internal Rate Of Ret) Can Be Compared To Bank Rates
WK 5: Capital Budgets
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Associated LabActivities
Calculation Of Investment Measures
-- Payback
-- Acct Rate Of Return
-- Book Rate Of Return
-- Net Present Value
-- Benefit/Cost
-- Internal Rate Of Ret
WK 5: Capital Budgets
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Self TestPres Val / Investment Benefit- Cost
Simplest Method
Budget For Big Items
Quantative Basis
Non-time Method W/O Salv
Compared To Bank Rates
Image, Pretige
Non-time Method With Salv
Time To Recover Investment
Pres Val - Investment
Payback
Capital
“Will It Pay”
Acct Rate
Time Methods
Qualitative Basis
Book Rate
Payback
Net Pres Val
WK 5: Capital Budgets
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Evaluation
Your Understanding Of These Capital Budget Concepts Will Evaluated On The Midterm To Be Given The Fifth Friday Of The Quarter (This Week!!!!!!!!)
WK 5: Capital Budgets
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MidtermThis Friday !!!!!
Part 1: Objective Questions (T/F, Mc, Etc)
10 Pts: Wk 1- Introduction
10 Pts: Wk 2- Economics & Records
10 Pts: Wk 3- Budgets (Cash, Ent, Etc)
10 Pts: Wk 4- Linear Programming
10 Pts: Wk 5- Capital Budgets
Part II. Problems
20 Pts: Economics 5 Pts: Budgets
18 Pts: Linear Prog 9 Pts: Investment
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NEXT TOPIC
TIMELINESS
INTERNATIONAL HARVERSTER W4