Corporate Financial Management Lecturer’s Guide

CFML_A01v3. QXD 8/6/08 351 PM page 1 lectors Guide bodied monetary Management Fourth stochastic varicap open Glen Arnold For further lecturer strong divert vindicate www. pearsoned. co. uk/arnold ISBN 978-0-273-71064-6 Pearson knowledge confine two hundred8 Lecturers adopting the main text are permitted to download and copy this guide as required. CFML_A01v3. QXD 8/6/08 351 PM rapsc exclusivelyion 2 Pearson culture particular Edinburgh furnish Harlow Essex CM20 2JE England and Associated Companies around the world Visit us on the World bulky Web at www. pearsoned. co. uk First published beneath the pecuniary clippingsPitman publish imprint in 1998 Second variation published 2002 Third mutant published 2005 Fourth chance variable published 2008 fiscal clippings paid bound 1998 Pearson reproduction Limited 2002, 2005, 2008 The right of Glen Arnold to be identified as author of this Work has been asserted by him in accordance with the Copyright, Design s and Patents spiel 1988. ISBN-978-0-273-71064-6 All rights reserved. Permission is hereby given for the material in this number to be reproduced for OHP transparencies and student hand show ups, without express permission of the Publishers, for educational purposes only.In all a nonher(prenominal) cases, no part of this publication whitethorn be reproduced, stored in a retrieval system, or transmitted in either form or by any means, electronic, mechanical, photocopying, recording, or otherwise without either the front compose permission of the Publishers or a licence permitting restricted copying in the United Kingdom issued by the Copyright Licensing Agency Ltd. , Saffron House, 6-10 Kirby Street, capital of the United Kingdom EC1N 8TS. This book whitethorn non be lent, resold, hired out or otherwise disposed of by way of trade in any form of binding or c everyplace other than that in which it is published, without the prior consent of the Publishers.CFML_A01v3. QXD 8/5/08 416 PM pageboy 3 CONTENTS Preface Location of answers to questions and problems SUPPLEMENTARY MATERIAL FOR CHAPTERS Chapter 1 The financial world Chapter 2 get off judgement Net put pry and interior direct of return Chapter 3 intent estimation Cash advert and applications Chapter 4 The end-making process for enthronization appraisal Chapter 5 Project appraisal cracking rationing, taxation and inflation Chapter 6 run a stake and mould appraisal Chapter 7 Portfolio supposition Chapter 8 The capital summation pricing model and multi-factor models Chapter 9 Stock marts Chapter 10 Raising justness capitalChapter 11 Long-term debt finance Chapter 12 Short-term and medium-term finance Chapter 13 Treasury and working capital management Chapter 14 Stock market dexterity Chapter 15 Value management Chapter 16 St footstepgy and note honor Chapter 17 Value-creation metrics Chapter 18 Entire unwaveringly value step Chapter 19 The make up of capital Chapter 20 Valuing sh ares Chapter 21 Capital structure Chapter 22 Dividend policy Chapter 23 Mergers Chapter 24 Derivatives Chapter 25 Managing exchange- pose jeopardize Pearson Education Limited 2008 5 6 7 10 14 20 24 29 33 38 40 43 47 51 54 58 59 64 66 72 74 77 81 84 86 91 96 3 CFML_A01v3.QXD 8/5/08 416 PM Page 4 Supporting resources Visit www. pearsoned. co. uk/arnold to find valuable online resources Companion Website for students ? teaching objectives for each chapter ? Multiple-choice questions with instant feedback to help test your learning ? Weblinks to relevant, limited Internet resources to facilitate in-depth independent research ? A wide plectron of FT articles, additional to those found in the book, to provide real-world examples of financial closing making in practice ? Interactive online flashcards that allow the ratifier to encounter definitions a superchargest the key terms during revision Searchable online glossary For instructors ? Complete, downloadable Instructors manual including answers for all question material in the book ? A fall guy new set of over 800 PowerPoint slides that rear end be downloaded and used as OHTs as well The regularly maintained Companion Website provides the following features ? Search mother fucker to help locate specific items of content ? E-mail results and profile tools to commit results of quizzes to instructors ? Online help and support to assist with website usage and troubleshooting For more cultivation please contact your local Pearson Education sales re redeemative or visit www. earsoned. co. uk/arnold CFML_A01v3. QXD 8/5/08 416 PM Page 5 PREFACE This Guide is designed to assist lecturers and tutors using integrated Financial Management fourth rendering. Supplementary material for chapters For each chapter The learning outcomes are outlined. Key points and concepts are listed. Solutions to selected numerical problems (those marked with an asterisk in the main book) are provided. Note that there is often more than one executable correct solution to a problem. Different answers, which nevertheless follow the system of logic of the argument turn ined in the text, may be acceptable.Overhead vagabondor transparency masters Also available on the website in PowerPoint for downloading are over 800 selected figures, tables and key points reproduced in a form suitable for creating overhead come acrossor transparency masters. These are position in the order in which they appear in unified Financial Management. The learning objectives and summary points from the chapters are also included. Glen Arnold Pearson Education Limited 2008 5 CFML_A01v3. QXD 8/5/08 416 PM Page 6 LOCATION OF ANSWERS TO QUESTIONS AND PROBLEMS (No answers given to those in final column)Chapter No Answered in appendix VII Answered in Lecturers Guide 1 whoremastervas answer required (see text) All (see note in Appendix VII) 2 1, 2, 4, 5, 6 3, 7 3 1, 2, 3, 6, 9, 11, 13, 15 4, 5, 7, 8, 10, 12, 14 4 1, 2, 4, 5 3 5 1 , 2, 3, 5, 6, 9, 10 4, 7, 8 6 1, 4, 5, 6, 7, 8, 9, 10, 11 2, 3, 12 7 1, 2, 3, 7, 8, 9, 10, 11, 12, 13, 15 4, 5, 6, 14a, b, c 8 1, 3, 4, 5, 7, 8, 9, 10 6, 7, 8, 9 14d 2, 6, 11 9 111 10 12 8 17, 911, 1319 11 1, 2, 3, 4, 5, 6, 10, 11, 13, 16 7 8, 9, 12, 14, 15, 1720 12 1, 2, 4, 9, 10, 11 5, 12 3, 6, 7, 8, 13, 14, 15 13 1, 4, 5, 7, 9, 10 3a, 6, 8, 23, 25a , 3b, 11, 12, 1322, 24, 25b, 25c 14 2 15 8, 9 1, 317 7, 10 16 16 14 17 1, 5, 6, 7 18 1, 2 19 2, 3 1 20 3, 4, 5, 6, 7, 9 8, 10 1, 2 21 2, 3, 6a, 9 1 4, 5, 6b, 7, 8 22 4, 5, 8 23 6 1, 3, 4, 5 2, 7, 8, 9 24 1, 2, 3, 4, 5, 7, 10 6, 8, 9 11, 12, 13 25 1, 2, 7, 8a, 10, 11 4, 9 3, 4b, 5, 6, 8b 6 2, 3, 4, 4a 8 1, 2, 3, 4, 7 Pearson Education Limited 2008 CFML_CH01v3. QXD 29/7/08 1725 Page 7 SUPPLEMENTARY MATERIAL FOR CHAPTERS Chapter 1 THE fiscal WORLD L EARNING OUTCOMES It is no good learning mathematical techniques and theory if you lack an overview of what finance is about.At the end of this chapter the reader provide dedicate a balanced perspective on the purpose and value of the finance function, at both the corporate and national level. More specifically, the reader should be able to describe ersatz views on the purpose of the military control and provide the wideness to any organisation of clarity on this point describe the uphold of the divorce of corporate ownership from day-to-day managerial control apologize the role of the financial manager detail the value of financial intermediaries cross-file an appreciation of the function of the major financial institutions and markets. K EY POINTS AND CONCEPTS Firms should clearly gear up the objective of the enterprise to provide a focus for finish making. goodish financial management is necessary for the achievement of all stakeholder goals. almost stakeholders will have their returns satisfied given just enough to make their contribution. whiz (or more) group(s) will have their returns maximised given any surplus after all others have been sat isfied. The assumed objective of the firm for finance is to maximise shareholder wealth. Reasons practical, a single objective leads to clearer decisions the contractual theory survival in a competitive world it is better for society counters the tendency of managers to play along goals for their own benefit they own the firm. Maximising shareholder wealth is maximizing purchasing power or maximising the geological period of discounted hard change flow to shareholders over a long duration horizon. Profit maximisation is not the same as shareholder wealth maximisation. Some factors a kale comparison does not allow for are future prospects risk story problems Pearson Education Limited 2008 7 CFML_CH01v3. QXD 29/7/08 1725 Page 8 Glen Arnold, Corporate Financial Management Lecturers Guide, 4th edition intercourse additional capital. Corporate governance. Large corporations normally have a separation of ownership and control. This may lead to managerialism where th e divisor (the managers) take decisions mainly with their interests in mind rather than those of the principals (the shareholders). This is a principal-agent problem. Some solutions link managerial rewards to shareholder wealth improvement sackings selling shares and the coup threat corporate governance regulation improve information flow. The efficiency of production and the well- being of consumers can be improved with the introduction of notes to a barter economy. Financial institutions and markets hike growth and progress by mobilising savings and encouraging investment. Financial managers contribute to firms success primarily by means of investment and finance decisions. Their knowledge of financial markets, investment appraisal methods, treasury and risk management techniques are vital for company growth and stability. Financial institutions encourage the flow of saving into investment by acting as brokers and asset transformers, thus alleviating the conflict of preferences between the primary investors (households) and the ultimate borrowers (firms). addition transformation is the creation of an intermediate security with characteristics appealing to the primary investor to rive funds, which are then made available to the ultimate borrower in a form appropriate to them. Types of asset transformation risk transformation matureness transformation volume transformation. Intermediaries are able to transform assets and encourage the flow of funds because of their economies of scale vis-a-vis the individual investor efficiencies in gathering information risk spreading transaction tolls. The secondary markets in financial securities encourage investment by enabling investor liquidity (being able to sell pronto and cheaply to another investor) while providing the firm with semipermanent funds. The financial go sector has grown to be of great economic significance in the UK. Reasons high income elasticity international comparative ad vantage. The financial sector has shown curious dynamism, innovation and adaptability over the last three decades. Deregulation, new technology, globalisation and the fast development of new financial products have characterised this sector. Banking sector Retail banks high-volume and low-value business. in king-size quantities banks low-volume and high-value business. Mostly fee based. International banks mostly Euro bills transactions. Building societies still primarily small deposits aggregated for mortgage lending. Finance houses hire purchase, leasing, factoring. 8 Pearson Education Limited 2008 CFML_CH01v3. QXD 29/7/08 1725 Page 9 Glen Arnold, Corporate Financial Management Lecturers Guide, 4th edition Long-term savings institutions Pension funds major investors in financial assets. Insurance funds life assurance and endowment policies provide large investment funds. The risk spreaders Unit trusts genuine trusts which are open-ended investment vehicles. Investment trusts companies which invest in other companies financial securities, particularly shares. open-ended investment companies (OEICs) a hybrid between unit and investment trusts. The risk takers Private equity funds invest in companies not quoted on a stock exchange. Hedge funds wide variety of investment or speculative strategies outside regulators control. The markets The money markets are short-term sell lending and/or borrowing markets. The bond markets deal in long-term bond debt issued by corporations, governments, local authorities and so on, and usually have a secondary market. The foreign exchange market one currency is exchanged for another. The share market primary and secondary trading in companies shares takes place on the Official List of the London Stock Exchange, techMARK and the election Investment Market. The derivatives market LIFFE (Euronext. liffe) dominates the exchange-traded derivatives market in options and futures.However there is a thrive over-the-counter market. There are no numerical questions in this chapter answers may be found from reading the text. Pearson Education Limited 2008 9 CFML_CH02v3. QXD 29/7/08 1726 Page 10 Chapter 2 determine APPRAISAL NET PRESENT VALUE AND INTERNAL RATE OF redeem L EARNING OUTCOMES By the end of the chapter the student should be able to instal an understanding of the fundamental theoretical justifications for using discounted property flow techniques in analysing major investment decisions, based on the concepts of the time value of money and the probability cost of capital.More specifically the student should be able to code net present value and internal rate of return show an appreciation of the relationship between net present value and internal rate of return describe and let off at least deuce potential problems that can arise with internal rate of return in specific circumstances demonstrate awareness of the propensity for management to save a percent age measure of investment performance and be able to use the modified internal rate of return. KEY POINTS AND CONCEPTS Time value of money has three component parts each requiring compensation for a delay in the receipt of cash the pure time value, or impatience to consume, inflation, risk. Opportunity cost of capital is the yield forgone on the surmount available investment alternative the risk level of the alternative being the same as for the fuddle under consideration. Taking account of the time value of money and fortune cost of capital in get word appraisal leads to discounted cash flow analysis (DCF). Net present value (NPV) is the present value of the future cash flows after netting out the initial cash flow. Present values are achieved by discounting at the opportunity cost of capital.NPV = CF0 + (1 + k)2 + CFn (1 + k)n 0 accept 0 freeze off CF1 1+r + CF2 (1 + r)2 + CFn (1 + r)n =0 The internal rate of return decision convening is IRR IRR 10 CF2 Internal rat e of return (IRR) is the discount rate which, when absorb to the cash flows of a project, results in a zero(a) net present value. It is an r which results in the following formula being true CF0 + 1+k + The net present value decision rules are NPV NPV CF1 opportunity cost of capital accept opportunity cost of capital reject Pearson Education Limited 2008 CFML_CH02v3. QXD 29/7/08 1726 Page 11Glen Arnold, Corporate Financial Management Lecturers Guide, 4th edition IRR is scummy at handling situations of unconventional cash flows. Multiple solutions can be the result. There are circumstances when IRR ranks one project higher(prenominal)(prenominal) than another, whereas NPV ranks the projects in the opposite order. This ranking problem becomes an important issue in situations of mutual exclusivity. The IRR decision rule is reversed for financing-type decisions. NPV measures in infrangible amounts of money. IRR is a percentage measure. IRR assumes that intra-project cash f lows can be invested at a rate of return equal to the IRR.This biases the IRR advisement. If a percentage measure is required, perhaps for communication within an organisation, then the modified internal rate of return (MIRR) is to be preferred to the IRR. ANSWERS TO SELECTED QUESTIONS 3 Confused plc a Project C IRRs at 12. 1% and 286%. See Fig. 2. 1. NPV + 12. 1 286 Discount rate Fig. 2. 1 Project D No solution using IRR. See Fig. 2. 2. + NPV Discount rate Fig. 2. 2 b This problem illustrates two disadvantages of the IRR method. In the case of project C multiple solutions are realizable, given the non-conventional cash flow.In the case of project D there is no solution, no IRR where NPV = 0. c NPV Project C +? 646 Project D ? 200 Using NPV the accept/reject decision is straightforward. Project C is accepted and Project D is rejected. Pearson Education Limited 2008 11 CFML_CH02v3. QXD 29/7/08 1726 Page 12 Glen Arnold, Corporate Financial Management Lecturers Guide, 4th edition 7 Seddet International a Project A At 20% 5,266 + 2, cholecalciferol ? 2. 1065 = 0, ? IRR = 20% Project B At 7% 8,000 + 10,000 ? 0. 8163 = +163 At 8% 8,000 + 10,000 ? 0. 7938 = 62 IRR = 7 + 163 163 + 62 (8 7) = 7. 7% Project CAt 22% 2, coke + 200 ? 0. 8197 + 2,900 ? 0. 6719 = +12. 45 At 23% 2,100 + 200 ? 0. 8130 + 2,900 ? 0. 6610 = 20. 5 IRR = 22 + 12. 45 12. 45 + 20. 5 (23 22) = 22. 4% Project D At 16% 1,975 + 1,600 ? 0. 8621 + 800 ? 0. 7432 = 1 ? IRR is slightly under 16%. The IRR exceeds the hurdle rate of 16% in the case of A and C. Therefore if all projects can be accepted these two should be undertaken. b rank under IRR Project Project Project Project C A D B IRR 22. 4% 20% 16% 7. 7% best project c Project A 5,266 + 2,500 ? 2. 2459 = 349 Project B 8,000 + 10,000 ? 0. 6407 = 1,593 Project C 2,100 + 200 + 0. 8621 + 2,900 ? 0. 7432 = 228 Project D 1,975 + 1,600 ? 0. 8621 + 800 ? 0. 7432 = 1 12 Pearson Education Limited 2008 CFML_CH02v3. QXD 29/7/08 1726 Page 13 Glen Arnold, C orporate Financial Management Lecturers Guide, 4th edition Ranking Project A Project C Project D Project B NPV 349 best project 228 1 1,593 Project A ranks higher than project C using NPV because it generates a larger surplus (value) over the required rate of return. NPV measures in absolute amounts of money and because project A is twice the size of project C it creates a greater NPV disrespect a lower IRR. This report should comment on the meaning of a positive or negative NPV expressed in everyday language. It should remark the time value of money and opportunity cost of capital and explain their meanings. Also the drawbacks of IRR should be discussed multiple solutions ranking problem link with the line of merchandise of a percentage-based measure and an absolute moneybased measure additivity not possible the reinvestment assertion is flawed. Pearson Education Limited 2008 13 CFML_CH03v3. QXD 29/7/08 1726 Page 14 Chapter 3 PROJECT APPRAISAL CASH advert AND APPLICATION S LEARNING OUTCOMESBy the end of this chapter the reader will be able to line and apply relevant and additive cash flows in net present value calculations. The reader will also be able to earn and deal with change posture costs, incidental expense costs and allocated overheads and be able to employ this knowledge to the following the reliever decision/the transposement motorcycle the calculation of annual equivalent annuities the make or corrupt decision optimum timing of investment fluctuating output situations. KEY POINTS AND CONCEPTS Raw info have to be checked for accuracy, reliability, timeliness, expense of collection, etc. Depreciation is not a cash flow and should be excluded. Profit is a poor substitute for cash flow. For example, working capital adjustments may be needful to modify the profit figures for NPV analysis. Analyse on the basis of incremental cash flows. That is, the difference between the cash flows arising if the project is implemented and th e cash flows if the project is not implemented opportunity costs associated with, say, using an asset which has an alternative employment are relevant incidental personal effects, that is, cash flow effects throughout the organisation, should be considered along with the obvious direct effects change posture costs costs which will not change regardless of the decision to proceed are clearly conflicting allocated overhead is a non-incremental cost and is irrelevant interest should not be double counted by both including interest as a cash flow and including it as an gene in the discount rate. The replacement decision is an example of the application of incremental cash flow analysis. Annual equivalent annuities (AEA) can be industrious to estimate the best replacement cycle for an asset under authorized restrictive assumptions. The lowest common multiple (LCM) method is sometimes sedulous for short-lived assets. Whether to repair the old machine or sell it and buy a new m achine is a very common business dilemma. Incremental cash flow analysis helps us to solve these types of problems. former(a) applications include the timing of projects, the issue of fluctuating output and the make or buy decision. 14 Pearson Education Limited 2008 CFML_CH03v3. QXD 29/7/08 1726 Page 15 Glen Arnold, Corporate Financial Management Lecturers Guide, 4th edition A NSWERS TO SELECTED QUESTIONS 4 Mercia plc a plan 1 Consultants fee sunk cost exchange overhead irrelevant Depreciation irrelevant Time ( forms) ?000s 0Earthmoving Construction ticket sales Operational costs Council Senior management Opportunity cost Cash flows 1,650 3? 2 100 1,650 Discounted Cash flows 1 150 1,400 200 +600 100 100 50 +600 100 50 +150 0 +450 150 (1. 1)2 450/0. 1 (1. 1)2 + NPV = + ? 2. 193m Proposal 2 Central overhead (? 70,000) irrelevant Consultants fees (? 50,000) sunk cost Time (years) ?000s 0 1 2 3 100 5,000 4,000 400 100 5,000 4,000 400 100 Design & stool Revenue Operating costs Equipment Executive Opportunity cost sale of club 9,000 Cash flow 9,100 100 Discounted cash flow 9,100 100 1. 1 100 +11,000 500 + 500 (1. 1)2 +11,500 + 11,500 (1. 1)3 NPV = ? 137,566 Recommendation accept object 1 IRR Proposal 1 20. 2% Proposal 2 9. 4% Pearson Education Limited 2008 15 CFML_CH03v3. QXD 29/7/08 1726 Page 16 Glen Arnold, Corporate Financial Management Lecturers Guide, 4th edition 5 Mines International plc a Survey sunk cost Time (years) ?m Profit (loss) Add depreciation Capital equipment Survey 0 1 2 3 4 5 0 0 4. 75 2. 1 0 4. 75 0. 30 3. 9 2. 0 4. 7 2. 0 4. 7 2. 0 2. 9 2. 0 1. 5 0 0 0 2. 0 2. 0 2. 0 2. 25 0. 25 2. 25 2. 25 0 2. 25 1. 75 +0. 50 1. 75 0 +1. 75 0. one hundred twenty-five 0. 125 0. 125 0. 10 0 0. 25 0. 10 0 0. 10 Debtor adjustment Opening debtors cloture debtors Creditor adjustment Opening creditors Closing creditors 0 0. 15 +0. 15 Overheads Hire cost Cash reserves Government refund Cash flow Discounted cash flow 0. 2 0. 15 0. 10 0. 10 0. 125 0. 05 +0. 025 0. 2 0. 2 0. 1 0. 2 1. 0 5. 125 0. 2 +1. 0 +0. 2 5. 75 5. 75 6. 20 4. 05 6. 575 6. 9 8. 075 1. 85 6. 20 + 4. 05 + 6. 575 + 6. 9 + 8. 075 + 1. 85 1. 12 (1. 12)2 (1. 12)3 (1. 12)4 (1. 12)5 (1. 12)5. 125 = 5. 75 5. 536 + 3. 229 + 4. 680 + 4. 385 + 4. 582 + 1. 035 = ? 6. 625m The maximum which MI should bid in the auction is ? . 625m. This additional cash outflow at time zero would result in a return of 12% being obtained. (Some students may time the final debtor and creditor payments at time 5. 25 as time 6. ) b IRR = 29. 4%. c Points to be covered Time value of money. Opportunity cost of money for a given risk class. Sunk cost. Treatment of depreciation. Allocated overhead treatment. Cash injections. Hire cost opportunity cost. Comparison of NPV with other project appraisal methods Advantages over IRR measures in absolute amounts of money ranking problem multiple solution problem. 16 Pearson Education Limited 2008 CFML_CH03v3. QXD 29/7/08 1726 Page 17 Glen Arnold, Corporate Financial Management Lecturers Guide, 4th edition Advantages over payback time value of money allowed for all cash flows considered cash flows within pay back period considered properly. Advantages over ARR firm theoretical base, time value of money defined decision criteria. 7 Reds plc One-year cycle Time (years) 0 1 10,000 12,000 8,000 4,000 NPV = 10,000 4,000 ? 0. 9009 = 13,604 AEA = 13,604 0. 9009 = ? 15,100 two-year cycle Time (years) 0 1 2 10,000 12,000 13,000 ,500 6,500 NPV = 10,000 12,000 ? 0. 9009 6,500 ? 0. 8116 = 26,086 AEA = 26,086 1. 7125 = ? 15,233 Three-year cycle Time (years) 0 1 2 3 10,000 12,000 13,000 14,000 3,500 10,500 NPV = 10,000 12,000 ? 0. 9009 13,000 ? 0. 8116 10,500 ? 0. 7312 = 39,039 AEA = 39,039 2. 4437 = ? 15,975 Reds should replace the machinery on a yearly cycle. Pearson Education Limited 2008 17 CFML_CH03v3. QXD 29/7/08 1726 Page 18 Glen Arnold, Corporate Financial Management Lecturers Guide, 4th edition 8 Immediate replacem ent Time (years) 0 1? +4,000 15,100 +4,000 15,100 0. 11 = ? 133,273Replacement after one year Time 0 + 2? 2,000 2,000 1 3,000 15,100 0. 9009 15,100/0. 11 1. 11 3,000 ? = ? 122,966 Replacement after two years Time 0 1 2 3? 2,000 1,000 +1,500 15,100 2,000 1,000 ? 0. 9009 + 1,500 ? 0. 8116 15,100/0. 11 (1. 11)2 = ? 113,097 Recommendation Commence replacement cycle after two years. 10 Curt plc Incremental cash flows Time (years) 0 70,000 28,000 28,000 37,000 47,100 68,410 ? ? ? ? ? 0. 8621 0. 7432 0. 6407 0. 5523 0. 4761 2 3 4 5 0 70,000 100,000 80,000 48,000 110,000 82,000 121,000 84,000 133,100 86,000 146,410 88,000 10,000 70,000 Current cash flowsNew plan 1 28,000 28,000 37,000 47,100 68,410 = = = = = = 70,000 24,139 20,810 23,706 26,013 32,570 8,960 The positive incremental NPV indicates that betrothal of the proposal to manufacture in-house would add to shareholder wealth. 18 Pearson Education Limited 2008 CFML_CH03v3. QXD 29/7/08 1726 Page 19 Glen Arnold, Corporate Financial Ma nagement Lecturers Guide, 4th edition different factors some possibilities The relative bargaining strength of Curt and its supplier. Perhaps a search for another supplier would be wise. Perhaps it would be possible to negotiate a multi-year price agreement.Are there some other incidental effects Curt has not considered, e. g. factory space usage? 12 Netq plc Output per year 1,000 ? 0. 3333 ? 2 1,000 ? 0. 3333 ? 0. 75 ? 2 1,000 ? 0. 3333 ? 0. 5 ? 2 = 667 500 333 1,500 Cost of annual output 1,500 ? ?4 = ? 6,000 PV = 6,000/0. 13 = ? 46,154 twain machines replaced Annual costs 1,500 ? ?1. 80 = ? 2,700 PV = 14,000 + 2,700 0. 13 = ? 34,769 One machine is replaced out of date Output first third of year second third of year last third of year New 333. 3 166. 7 0 500 333. 3 333. 3 333. 3 1,000 Annual costs 500 ? 4 + 1,000 ? 1. 8 = ? 3,800 PV = 7,000 + 3,800 = ? 6,231 0. 13 The lowest cost option is to replace both machines. 14 Opti plc Costs One-year replacement PV = 20,000 6,000/1. 1 = 14,545 AEA = 14,545/0. 9091 = 16,000 Two-year replacement PV = 20,000 + 6,000/1. 1 1,000/(1. 1)2 = 24,629 AEA = 24,629/1. 7355 = 14,191 Three-year replacement PV = 20,000 + 6,000/1. 1 + 8,000/(1. 1)2 + 4,000/(1. 1)3 = 35,072 AEA = 35,072/2. 4869 = 14,103 Four-year replacement PV = 20,000 + 6,000/1. 1 + 8,000/(1. 1)2 + 10,000/(1. 1)3 + 10,000/(1. 1)4 = 46,410 AEA = 46,410/3. 1699 = 14,641 The optimal replacement cycle is 3 years. Pearson Education Limited 2008 9 CFML_CH04v3. QXD 29/7/08 1727 Page 20 Chapter 4 THE DECISION-MAKING touch FOR INVESTMENT APPRAISAL LEARNING OUTCOMES The main outcome expected from this chapter is that the reader is aware of both traditional and discounted cash flow investment appraisal techniques and the extent of their use. The reader should also be aware that these techniques are a small part of the overall capital-allocation planning process. The student is expected to gain knowledge of the empirical evidence on techniques used the calculation of p ayback, discounted payback and accounting rate of return (ARR)