PPT Introduction to Capital Budgeting and Financing of Capital Projects PowerPoint presentation
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Introduction to Capital Budgeting and Financing of Capital Projects
Case study and small group exercise on cost identification. Modify existing equipment, processes, and management & information systems to. PowerPoint PPT presentation
Tellus Institute
Introduction
Course Background
- 15 min
Development of the training materials
- Content has been developed by
- Tellus Institute
- Gloucestershire Business School, UK
- The Illinois EPA
- The Philippine Institute of CPAs
- The Asian Institute of Management
- UNEP CP financing National Project Coordinators
in Zimbabwe and Guatemala
UNEP Financing Cleaner Production Support
- Division of Technology, Industry, and Economics
- This course results from the project
- Strategies and Mechanisms For Promoting Cleaner
Introduction of Instructors
- 15 min
Cleaner Production is.
- The continuous application of an integrated
preventive environmental strategy applied to
overall efficiency and reduce risks to humans and
the environment.
Cleaner Production is different
- Much of current environmental protection focuses
on what to do with wastes and emissions after
they have been created, otherwise known as
end-of-pipe disposal treatment
generating pollution in the first place
Environmental Management hierarchy
- CLEANER PRODUCTION
- Pollution Prevention
- On-site Recycling/Reuse
Cleaner Production
- Production processes conserving raw materials
energy, eliminating toxic raw materials, and
Cleaner Production benefits
- Reduces costs (of raw materials, energy, waste,
emissions)
environment)
operations
Welcome bySenior Official
- 15 min
Participant Introductions
- 30 min
Who is here today?
- What type of organization do you work for?
- e.g. industry, government, other
- If from industry, which sector and what size
- What are your job responsibilities and areas of
expertise?
engineering, production, environmental
of investment proposals
Why are you here?
- What work issues or concerns motivated you to
come?
Course Overview
- 15 min
Todays focus
- Capital Budgeting
- Project Financing
- Also to incorporate your experiences, questions,
and goals into todays presentation,exercises,
discussions
In the context of Cleaner Production
Investment projects
- Investment projects and company value
- Discussion of course participant experiences with
investment projects
Capital budgetingIntroduction
- Capital budgeting definition and main
implementation steps
identification
Capital budgetingProfitability Assessment
- Estimating project profitability with Net Present
Value (NPV)
Project financing
- Project financing sources
- Discussion of course participant experiences with
project financing
information requirements
Conclusion
- Other issues?
- Where to go for more information
- Brief review of what we learned today
- Course evaluation
Time for a break! 15 min
INVESTMENT PROJECTS
Investment Projects and Company Value
- 15 min
Companies Projects
- Think of a company as a collection of projects
that fit together
company as a whole
Company goals
- The basic goal of any organization
- Survive and prosper!
- Economic survival depends on
- Generating income (profits, cash flows)
- Raising capital from investors lenders that
supports generation of income
the companys income as an adequate return on
their capital investment.
Investors and lenders (1)
- Two main potential sources
- Investors ( owners, shareholders, equity)
- Lenders ( debt)
- (Sometimes called financial stakeholders)
- Both types will require a reasonable return on
their capital or may withdraw their support
Investors and lenders (2)
- Withdrawal of support by investors lenders
could mean collapse of company
Company value — Acme (1)
Acme
Company value — Acme (2)
lenders if they expect
20 If investors/lenders consider Acme to be a
risky company and require 30, then Acmes value
will be less 12,000 40,000 30
Discussion of Course Participant Experienceswith
Investment Projects
- 30 min
Questions for discussion
- Think of examples of capital investment projects
that have been implemented (or funded) by your
organization
Cleaner Production (CP) projects?
Investment Projects Summary
- 15 min
Investment projects (1)
- An investment project might focus on
- A production process
- Production or other equipment
- A product
- An information or management system
- etc.
- Investment projects might focus on existing
equipment, processes, or products or focus on
brand-new ones
Investment projects (2)
- Some investment projects require only a moderate
investment of time/labour
(i.e. investment funds) for the purchase of
physical assets such as equipment
Investment projects (3)
- Timing and frequency of investment projects and
amount of investment capital required may vary
with
periodically need capital for investment projects
Typical project types goals (1)
- Maintenance
- Maintain existing equipment operations
- Improvement
- Modify existing equipment, processes, and
management information systems to improve
efficiency, reduce costs, increase capacity,
improve product quality, etc.
or outdated/inefficient management information
systems
Typical project types goals (2)
- Expansion
- e.g. obtain and install new process lines,
initiate new product lines
recycling, reduce waste generation, install waste
product quality also reduces the use and purchase
cost of toxic chemicals, as well as disposal
costs
narrow category think broadly about all the
possible benefits
Project implementation process
- Capital budgeting
- Identify company goals strategies identify
potential projects evaluate projects select
projects to implement
external capital if needed
review learn for next time!
CAPITAL BUDGETINGINTRODUCTION
Capital Budgeting -Definition and Main
Implementation Steps
- 15 min
Capital budgeting
- The process by which an organization
- Decides which investment projects are needed
possible, with a special focus on projects that
different projects
Capital budgeting practices
- Capital budgeting practices vary widely from
company to company
practices than smaller companies
capital investments than smaller companies
investment than others
country to country
Basic capital budgeting steps
- Identify potential projects
- talk to employees, industry colleagues, trade
association, suppliers/vendors, government
technical assistance office
financial evaluation
availability of capital
Decision-making factors
Technical
Project selection
Regulatory
Financial
Organizational
Financial analysis steps
- Estimate cash flows
- Characterize project risk
- Select required rate of return on project
- Calculate project profitability
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We will discuss this now
We will discuss these after lunch
Cost identification estimation
- Initial investment costs
- e.g. equipment, installation, training
- Annual operating costs, savings,and revenues
- Current operations, before the project
- After project implementation
- e.g. materials, energy, labour
- Need to identify, estimate, and allocate all
Case Study Small Group Exerciseon Cost
Identification
- 30 min
Exercise instructions
- Break into small groups
- Review the company description
- Work with your group to answer question 1
- Work with your group to answer question 2
- Discussion of answers as entire class
Converting cash flowsto their present value
- You can convert future year cash flows to their
present value using a discount rate that
incorporates
mathematically, it is the reverse of an interest
rate calculation
Net Present Value
- Net Present Value (NPV) is the sum of the present
values of all the projects cash flows
profitable since it will increase total company
value
profitable since it would destroy value
Discounting
- Expressing future amounts in terms of their
present value is called discounting
combination of
Question If Acme wants to borrow 18,000 in
order to finance a new project, what factors are
likely to influence how much interest it will
have to be prepared to pay?
Return, risk, and inflation
- Basic Rate
- pure compensation for deferring consumption
- even if there is no risk or inflation
- Risk
- of the particular investment
- the risk premium
- Inflation
- expected fall in the value of money over time
What Rate of Return?
- What amount should be set as the required rate
of return for a project?
finance from investors/ lenders (i.e. the
companys cost of capital)
incorporate 3 distinct elements
consumption
time through inflation
Questions(1) What is a typical rate of return
at your organisation?(2) Do you use this rate
of return in capital budgeting?
Summary (1)
- Money has more value now than it does in the
future
money and risk
Summary (2)
- Discount rate level reflects cost to company of
raising capital
discount rates
money into its present value (like exchange rates
with foreign currencies)
NPV and Cleaner Production Projects
- Any special issues in doing NPV analyses on CP
projects?
Influences on Project Appraisal
- 20 min
Acmes CP project
- Potential project
- initial investment (now) 18,000
- net cash inflows each year 9,600
- life of project 3 years
- discount rate (per year) 20
- Projected NPV 2,221
- BUT what could go wrong.
Acmes CP project
- 4 main items in the data analysis
- initial investment (now) 18,000
- net cash inflows each year 9,600
- life of project 3 years
- discount rate (per year) 20
- If any of these deteriorate too far, NPV may fall
below zero and the project would not be viable.
to zero?
Initial investment
PV of future cash inflows 20,221 Expected
initial investment 18,000 Net Present
Value (NPV) 2,221 If cost of initial
investment were to increase by more than 2,221
(12.3) then project would not be worthwhile
Project life (1)
- The project could have to finish early for any of
several possible reasons, e.g.
future cash flows
Payback (discounted)
- Payback period can alternatively be calculated
based on discounted future cashflows
time value of money (at least partly)
correct), the payback period would be 27.5 months
Discount rate
- The rate at which the Net Present Value is zero
(27.76, here) is the projects
it can raise the money needed to finance it at a
lower rate than this.
finance, the project will destroy value.
Alternative project appraisal methods Summary
- Net Present Value (NPV)
- Internal Rate of Return (IRR)
- Payback (simple or discounted)
Net Present Value (NPV)
- net amount of discounted future
- cashflows less initial investment
- ? reflects amount (in ) added by
- project to total company value
- ? recognizes time value of money
- ? complex to calculate
- ? needs prior estimate of cost of
- raising capital
Internal Rate of Return (IRR)
- discount rate at which NPV 0
- ? basis to compare with costs of
- different sources of finance
- ? recognises time value of money
- ? complex to calculate
- ? does not directly reflect impact
- on value
Payback
- time needed for net cash inflows to equal the
initial investment
than expected
of money
PROJECT FINANCING
Project Financing Sources
- 30 min
What are the different sources of project
financing available?
Questions
- What sources has your company raised capital from
in order to finance projects?
grants, other )?
Potential sources of project financing
- A. Internal funds
- B. Private sector
- 1. commercial banks
- 2. development corporations
- 3. equipment vendors/ subsidiary
- finance companies
- 4. owners capital (equity)
- C. Governmental sector
- grants/ earmarked capital from
governmental programmes
Investing and financing decisions
- Distinguish between
- The investing decision
- The financing decision
- Investing decision is the project acceptable?
(i.e. does it have a positive NPV, at the
relevant discount rate?)
the cheapest) way to fund it?
Internal funds and the financing decision
- Internal funds are generated from past cash flows
- Internal funds (if available) are usually the
best source, but
be done with these funds? (e.g. finance other
projects, invest in financial securities, etc.)
preferable to internal funds
The variety of securities for Financing Companies
- International firms use different kinds of
securities
on plant and equipment)
small and medium-sized companies?
without conditions on how the borrower must use
those funds)
Development corporations
- Development corporations/banks are established to
contribute to the economic development of a
particular community or region
apply for loans
are you aware of?
Equipment vendors and Subsidiary finance companies
- Leasing has become a major source of financing
that is provided by some equipment vendors and
subsidiary finance companies (lease-providers).
operates it (the lease-holder)
interest in the equipment
the rewards of ownership
Owners capital (equity)
- Represented by ordinary shares in a company (or
stock)
available
shareholdings of present shareholders
Share issues
- Public issues of stock
- For larger companies
- Requires a stock market listing
- Substantial administrative costs
- Not usually suitable for single projects
- Private placements of stock
- Stock is bought by private persons but not on a
public market
Financing projectsSummary (1)
- Keep the financing decision distinct from the
capital budgeting decision
company
possible sources (differences may be huge!)
potential sources of finance
Financing projectsSummary (2)
- The main factors are
- How much capital is available in the country
- The characteristics of CP-projects
- Important characteristics of each application
include
Financing projectsSummary (3)
- Each source of capital has its own mechanisms
which the company has to manage
maximum ratio of debt to equity, to limit risk)
Time for a break! 20 min
Bank Information Requirements
- 55 min
from you?
provide to support your application?
Typical information to evidence a companys
credit-worthiness (1)
- Historical financial statements for the past
three years (balance sheet, income statement)
years (balance sheet, income statement, cash flow
forecast)
Acmes Balance Sheet (in 000)
- Capital liabilities
- Share capital 60
- Retained 42
- profits
- Accounts 23
- payable ____
- 125
- Assets
- Equipment 73
- Inventory 21
- Accounts 29
- receivable
- Cash 2
- ___
- 125
Acmes Income Statement (in 000)
- Sales revenue 203
- less Cost of goods sold — 156
- GROSS PROFIT 47
- less Overhead (indirect) costs — 35
- e.g. staff costs, rent, etc.
- NET PROFIT 12
Typical information to evidence a companys
credit-worthiness (2)
- For sole traders and partnerships personal
financial statements and/or tax returns of the
owner(s)
other loans or leases
Presenting a fund application
- Acme wants to implement its 3-stage rinse CP
project. The project requires an initial
investment of 18,000 but Acme has only 2,000
in cash, which it needs for day-to-day
finance. Three potential sources have been
identified
Presenting a fund applicationCommercial bank
- An application to a commercial bank should focus
on
investment
swiftly to future changes in environmental
regulation
Presenting a fund application Development bank
- An application to a development bank should focus
matching grant, e.g.from a government programme
cash flows from the investment