6.1 CAPITAL PROJECTS 6.2 CAPITAL BUDGETING PROCESS 6.3 CAPITAL PROJECT ANALYSIS 6.4 BUSINESS EXPANSION STRATEGIES

Size: px

Start display at page:

Download "6.1 CAPITAL PROJECTS 6.2 CAPITAL BUDGETING PROCESS 6.3 CAPITAL PROJECT ANALYSIS 6.4 BUSINESS EXPANSION STRATEGIES"

Ashley Bradley
6 years ago
Views:

1 Chapter 6 Long-Term Financial Activities 6.1 CAPITAL PROJECTS 6.2 CAPITAL BUDGETING PROCESS 6.3 CAPITAL PROJECT ANALYSIS 6.4 BUSINESS EXPANSION STRATEGIES

2 Lesson 6.1 Capital Projects Goals Describe types of capital projects used in business. Explain factors that affect capital spending decisions. Slide 2

3 Terms capital project intellectual property mutually exclusive projects complementary projects Slide 3

4 Capital Spending Activities capital project (capital expenditures) the construction or purchase of a longterm asset capital spending the process of spending money to pay for capital projects Slide 4

5 REPLACEMENT PROJECT Failure to replace items in a timely manner can result in higher costs lost sales reduced profits Slide 5

6 COST-SAVING PROJECT New technology enables companies to purchase equipment that reduces operating costs. Slide 6

7 NEW PRODUCT OR NEW MARKET When a new product is manufactured or when an existing product is revised, new equipment is often required. capital spending results Slide 7

8 intellectual property intangible assets used by companies trademarks brand names copyrights patents software licensing agreements Slide 8

9 GOVERNMENT-REQUIRED PROJECT Government regulations require compliance from every organization. Slide 9

10 SOCIAL BENEFIT PROJECT Sometimes a company will undertake a project not directly related to its business. Slide 10

11 Describe the five main types of capital projects. Slide 11

12 Project Selection Factors INDEPENDENT PROJECTS independent projects projects are not affected by each other Slide 12

13 MUTUALLY EXLUSIVE PROJECTS mutually exclusive projects situations in which the acceptance of one project does not allow acceptance of others Slide 13

14 COMPLEMENTARY PROJECTS complementary projects when two or more projects are dependent on each other Slide 14

15 How do mutually exclusive projects differ from complementary projects? Slide 15

16 Lesson 6.2 Capital Budgeting Process Goals Discuss the steps in the capital budgeting process. Explain factors that affect the cost of capital. Slide 16

17 Terms cost of capital cost of debt cost of equity optimal capital structure weighted average cost of capital (WACC) Slide 17

18 Making Capital Decisions The purchase of long-term assets is vital for the current and future success of every organization. capital budgeting the process of selecting long-term assets Slide 18

19 Slide 19

20 1. SET CAPITAL SPENDING GOALS Organizational goals should influence the selection of capital projects. maximize the value of the firm the goal of a business Slide 20

21 Non-profits have different capital spending goals. improved community service reduced operating costs expanded visibility to attract additional donations Slide 21

22 2. DETERMINE POTENTIAL PROJECTS The clear identification of capital spending goals helps determine appropriate projects to work on in support of those goals. Slide 22

23 3. FORECAST CASH FLOWS A quantitative project analysis needs to be prepared. reflecting the cash inflows and outflows that are a direct result of the project cash inflows additional net sales and revenues reduced operating expenses Slide 23

24 Other factors to consider include: inflation depreciation the decrease in the value of an item as a result of time and use not part of cash flow calculations non-cash item money is not paid out when depreciation is recorded Slide 24

25 4. IDENTIFY COST OF CAPITAL AND RISK cost of capital (discount rate) the interest rate used to evaluate a capital project a percentage potential risks are identified and assessed high risk can increase the cost of capital Slide 25

26 5. SELECT AND IMPLEMENT PROJECT Managers decide which capital projects will be selected. quantitative and qualitative factors will be considered The management team puts the selected projects into operation. Slide 26

27 What are the steps of the capital budgeting process? Slide 27

28 Cost of Capital cost of capital (required rate of return) the rate required by lenders and investors who are letting the company use their money Slide 28

29 COST OF DEBT cost of debt the rate of return required by creditors Benefits associated with using debt include: The company is using the money of others, allowing the business to keep its funds available for other uses. Slide 29

30 Creditor risk is lower since debts are legal obligations. The cost of capital is lower than other funding sources as a result of the lower risk for lenders. Interest payments on debt are tax deductible as a business expense. Slide 30

31 COST OF EQUITY cost of equity the required return of the owners of a company the percent the company owners expect to earn based on the money they have invested in the company return might be in dividends increased market value of company Slide 31

32 OPTIMAL CAPITAL STRUCTURE optimal capital structure an appropriate balance between the amount of debt and the amount of equity the financing combination of a low cost of capital and maximum market value Slide 32

33 Factors to consider when seeking optimal cash structure include The company s current debt obligations The company s ability to borrow additional funds or issue additional bonds Stockholders sensitivity to current risk because of existing debt Historical and projected profitability of the company Slide 33

34 WEIGHTED AVERAGE COST OF CAPITAL (WACC) weighted average cost of capital (WACC) calculated by multiplying the proportions of debt and equity times the capital cost for each Slide 34

35 Every organization attempts to minimize its WACC. occurs when a certain combination of debt and equity are used the exact combination varies across companies and changes as risk and interest rates change Slide 35

36 Why is the cost of debt lower than the cost of equity? Slide 36

37 Lesson 6.3 Capital Project Analysis Goals Describe tools used to analyze capital projects. Explain factors that influence capital project decisions. Slide 37

38 Terms payback method net present value (NPV) internal rate of return (IRR) sunk cost Slide 38

39 Capital Decision Tools PAYBACK METHOD payback method determines how long it will take for the cash flows of a capital project to equal the original cost drawbacks to the payback method favors short-term projects which may not be in the best interest of the company neglects the time value of money Slide 39

40 NET PRESENT VALUE net present value (NPV) calculates the present value of cash flows for a project minus the initial investment Slide 40

41 Components of NPV include: initial investment (start-up cost) cost of the project cash flows annual amounts of increased sales or decreased costs the financial benefits of the project cost of capital (discount rate) the interest rate the company will use to calculate the present value of the cash flows Slide 41

42 CALCULATE NET PRESENT VALUE Step 1 Calculate the present value of cash flows. Step 2 Subtract the initial cost from the total in Step 1. Step 3 Evaluate the result. Slide 42

43 If the NPV is positive, accept the project. If the NPV is negative, reject the project. When considering several projects, accept the one with the highest NPV. Slide 43

44 INTERNAL RATE OF RETURN internal rate of return (IRR) the discount rate at which the net present value is zero provides a rate of return for a capital project reports a percentage rather than a dollar amount Slide 44

45 What three decision-making tools are commonly used to evaluate capital projects? Slide 45

46 Additional Analysis Factors OPPORTUNITY COST the value of the alternative that is given up when a decision is made cannot always be measured in monetary value Slide 46

47 SUNK COST sunk cost an expense that has been paid that will not affect capital decisions Slide 47

48 RISK ANALYSIS Risk can be viewed from a variety of perspectives. Geography Economic Conditions Slide 48

49 Social and Cultural Factors informal trade barriers cultural differences that lead to uncertainties when doing business in different regions Political and Legal Restrictions formal trade barriers specific government regulations restricting certain business activities Slide 49

50 How do opportunity costs and sunk costs differ? Slide 50

51 Lesson 6.4 Business Expansion Strategies Goals Explain business growth and expansion actions. Identify actions for reducing global business risks. Slide 51

52 Terms centralized organization decentralized organization horizontal integration vertical integration diversification joint venture Slide 52

53 Business Growth Actions ORGANIZATIONAL STRATEGIES centralized organization decisions are made at company headquarters decentralized organization allows company decisions to be made at lower levels of the organization Slide 53

54 EXPANSION METHODS horizontal integration a merger between two or more companies in the same type of business vertical integration a company expands through increased involvement in different stages of production and distribution Slide 54

55 PRODUCT VARIATIONS Growth often occurs by offering more and different products. new flavors different package sizes varied brands Slide 55

56 DIVERSITY OF MARKETS market where and to whom a business sells B2C (business to consumer) B2B (business to business) Slide 56

57 How does a centralized organization differ from a decentralized one? Slide 57

58 Reducing Global Risks There are four suggested methods for reducing international business risk. Slide 58

59 CONDUCT BUSINESS IN SEVERAL REGIONS Political unrest or poor economic conditions can lead to lower profits. Conducting business in multiple regions of the world reduces risk. Slide 59

60 DIVERSIFY PRODUCT LINES diversification offering a variety of products or services allows a company to balance lower sales in one division with higher sales in its other product lines Slide 60

61 INVOLVE LOCAL OWNERSHIP joint venture an agreement between two or more companies to share a business project Slide 61

62 EMPLOY LOCAL MANAGEMENT local managers can create favorable business relationships in a foreign business environment have knowledge of local customs and cultural business practices Slide 62

63 What actions can be taken to reduce global business risk? Slide 63

64 Performance Indicators Evaluated Identify the business s customer service offerings. Design a marketing research study to determine the clientele s customer service preferences. Conduct the market research. Compare customer service offerings. Slide 64

65 Recommend improvements for customer service offerings. Prepare a promotional campaign to promote the business s proposed customer service offerings based on the market research. Present the research findings and proposed promotional campaign to the business s manager in a role-play situation. Slide 65

66 Think Critically 1. Why is it important for a company to know what the competition offers for customer service? 2. Why is accurate marketing research so important? Slide 66

What incentives can be used to encourage customers to

67 3. What is the advantage of a company using a third party to conduct research and make recommendations? 4. What incentives can be used to encourage customers to participate in a marketing research survey? Slide 67

Engineering Economics and Financial Accounting

Engineering Economics and Financial Accounting Unit 5: Accounting Major Topics are: Balance Sheet - Profit & Loss Statement - Evaluation of Investment decisions Average Rate of Return - Payback Period