PRODUCT DEVELOPMENT “ Creating Value Internally”
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Transcript of PRODUCT DEVELOPMENT “ Creating Value Internally”
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PRODUCT DEVELOPMENT“Creating Value Internally”
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TYPES OF CAPITAL EXPENDITURES
• PURCHASE NEW EQUIPMENT• REPLACE EXISTING ASSETS• INVESTMENTS IN WORKING CAPITAL• MERGER AND ACQUISITION ANALYSIS
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THE CAPITAL BUDGETING PROCESS
• GENERATE PROJECT PROPOSALS• ESTIMATE CASH FLOWS• EVALUATE ALTERNATIVES• SELECT PROJECTS
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ESTIMATING CASH FLOWS
• CASH FLOWS MUST BE INCREMENTAL• USE AFTER TAX CASH FLOWS• INDIRECT EFFECTS MUST BE INCLUDED• SUNK COSTS MUST NOT BE CONSIDERED• USE OPPORTUNITY COSTS TO MEASURE VALUE
OF RESOURCES
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NET INVESTMENT IS THE INITIAL CASH OUTLAY
PROJECT COST PLUS SHIPPING AND INSTALLATION PLUSINCREASES IN NET WORKING CAPITAL MINUSPROCEEDS FROM SALE OF EXISTING ASSETS MINUSTAXES ASSOCIATED WITH SALE OF OLD EQUALSNET INVESTMENT
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CASH FLOWS AFTER TAX• CHANGE IN REVENUE• LESS: CHANGE IN OPERATING COSTS• LESS: CHANGE IN DEPRECIATION• EQUALS: CHANGE IN OPERATING EARNINGS• LESS: TAXES• EQUALS: CHANGE IN AFTER TAX OPERATING
EARNINGS• PLUS: CHANGE IN DEPRECIATION• LESS: CHANGE IN NET WORKING CAPITAL• EQUALS: NET CASH FLOW
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DECISION CRITERIA
• NET PRESENT VALUE• INTERNAL RATE OF RETURN• PROFITABILITY INDEX• PAYBACK PERIOD
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NET PRESENT VALUE
Present value of an investment = discounted value of cash flows- investment
PV = future cash flows - Investment
= + + +
-
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DISCOUNT FACTOR
N
Tk t
1)1(
1DF =
the amount by which cash flows received in the future lose value
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DISCOUNT FACTOR
Discount Factor for cash flows discounted for one year at 10%
DF= 1/1.10 = .909
Discount Factor for cash flows discounted for two years at 5%
DF= 1/(1.05)2= .952
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NPV- EXAMPLE
PV= (CFAT)/(1+R)N + (CFAT)/(1+R)N+1
PV =(100)/(1.10)1 + (100)/(1.10)2
PV= (100)(.909) + (100)(.826)
PV= 173.50
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SUBTRACT NET INVESTMENT
Net investment is the initial cash outlay for the project
Discounted Cash Flow - Investment= NPV
Decision Rule: If NPV> 0, Accept Project
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NPV - EXAMPLE
IF NINV IS $150, THEN;
NPV = $173.50 - 150 = $23.50
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INTERNAL RATE OF RETURN
NINVR
CFATN
TT
1 )1(
The interest rate that equates DCF with Net Investment
$100/(1+ R)1 + $100/(1+R)2 = $150
IRR = .10
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PAYBACK PERIOD (PB)
PB = NET INVESTMENT/ANNUAL CASH FLOWS
PB = $150/$100 = 1.50 YEARS
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PROFITABILITY INDEX
PI= PV of CASH FLOWS NINV
PI = $90.90 + $82.60$150
= 1.16
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Management 290business policy
exercise
Calculate the net present value of a project with a net investment of $20,000 for equipment and an additional net working capital
investment of $5,000 at time zero.The project is expected to generate net cash flows of $7,000 per
year over a 10 year period. In addition the working capital will be recovered at the end of the tenth year.
The required rate of return on the project is 11%. What is the meaning of the computed net present value figure.
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SOLUTION TO CAPITAL BUDGETING PROBLEM
NET INVESTMENT = $20,000 + $5,000 = $25,000
CASH FLOW AFTER TAX = $7,500/year
THEREFORE; CFAT for ten years = N)11.1(/7500$10
1
= $7500(5.889) = $44168
AND, Recovery of Working Capital is; $5000/(1.11)10 = $5000(.352) = $1760
NPV = -$25000 + $44168 + $1760 = $20,928
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CLUB MED
THE BUSINESS THEY ARE IN;
• They operated more than 100 villages in 36 countries
• The 1970’s image- “ a round trip ticket to sun,sea,…, and sex
• 1997 loss was more than $230 million
• They had lost family and younger segments
THE STRATEGIC PLAN -Three year, $580 million outlay;
•Advertising campaign aimed at families
•offer off-peak prices and packages
•close unprofitable villages
•renovate two-thirds of the remaining ones
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CLUB MED
THE $58 MILLION PLAN;
• $330 million in renovations (26 villages)
• $180 million for marketing and advertising
• $70 million for working capital
THE FINANCING;
• Issue $70 million in common stock
• Borrow $270 million in short term notes (from bank)
• Issue $140 million in debt (bonds)
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CLUB MED
THE RESULTS;
European revenues rose 9.7% to $1 billion
Canned 70 of Club Med’s middle managers
Fired 13 of 14 top managers
Cut $15 million from operating budget
Closed eight villages
In 1998, earned $30 million on revenues of $1.5 billion
Stock price recovered to $103 from $70 (1997)