Topic: Present Value and Capital Budgeting
Present Value and Capital Budgeting
Assignment: Part I
One specialized type of security is called an equity futures. This is a contract that guarantees you a share of a particular company to be delivered to you not today, but sometime in the future, at a price that is determined by the market right now. This price is usually called the futures price of the stock (note – the term is plural – “futures”). If you ‘buy’ this futures, you don’t pay for the shares now. You are actually signing a contract whereby you are committed to pay that price in a particular date in the future, and you are guaranteed to receive one share of the company at that time, irrespective of its actual market price at that future date. Suppose for example that the futures price of the XYZ Company is $40. Suppose you ‘buy’ a 6-months futures contract. If six months later the share price is $45, you gain $5 per share. If the market price in 6 months is only $35, then you lose $5.
Using the Yahoo Finance take a look at the five year chart for your reference company (DELL). Using this chart and other information you can find on this company, write a paper answering the following question:
What do you think would the futures price of 100 shares of your reference company to be delivered to you in one year be right now?
Assignment Expectations:
Part I:
This part is to be two pages long. You DO NOT need to use complex mathematical formulas for this assignment. Instead, think about how much do you think the market value of 100 shares of your company will be in one year? In considering the possible answers please reflect also on the following:
Do you expect the price of the shares in one year to be much higher? Or lower? Or only a little bit higher?
How risky the stock is. Is its price prone to wild swings up and down? Or has the price been relatively stable the last few years?
What alternative investments you have access to. What rate does your bank give you on a savings account or certificate of deposit? The greater return you can get on other investments, the less you would be willing to pay for an equity future.
Part 1
Readings:
One of the most common questions I get concerns “Where can I find the present value formula?”. While almost all of the links in this Module include the formula, here is a link where the formula is presented very prominently:
McCraken, M.E. (2009). The Time Value of Money. Retrieved April 1, 2012 from: https://www.teachmefinance.com/timevalueofmoney.html
However, do not just fixate on the formulas. While you need to know the formula for the assignments, you also need to understand the logic and intuition behind the formulas. The following link is important not only for the formulas but also to help you understand the material.
Time Value of Money: Self Paced Overview. (n.d.). Retrieved February 25, 2009 from: https://www.studyfinance.com/lessons/timevalue/index.mv
Part II
Every company has capital projects. The company you have selected (DELL) must need something! Be it a new wing to the building, a new product line to be funded, a new piece of equipment, find one new acquisition your company needs.
Once you have identified the new possible investment item, what problems are you going to have in estimating the cash flow that might be emanating from the initial investment and problems in getting it funded? Issues might be:
• Risk
• Cost
• Politics (getting it through committees)
• Public Relations
• etc.,
Identify a potential capital project for your company, describe such a project and write a short summary of the problems you see in getting the funding to see it through.
Assignment Expectations:
Part II:
This part should be three pages in length, and should have references to the background materials or other sources you found for this paper. It must discuss both the estimates of the initial investments and the annual incremental after-tax cash flow that is expected to emanate from the investment.
Part II
Readings:
Many of you are eager to start off with the formulas for capital budgeting, so this link is a good place to review the main formulas:
McCracken, M.E. (2005) Capital budgeting, retrieved August, 2008 from: https://teachmefinance.com/capitalbudgeting.html
Here is an example of net present value using Microsoft Excel:
Microsoft Office Online, (n.d.) NPV, retrieved August 2008 from: https://office.microsoft.com/en-us/excel/HP052091991033.aspx
Here is another example of net present value:
Anthes, G. (2003) ROI guide: Net present value, retrieved August 2008 from: https://www.computerworld.com/action/article.do?command=viewArticleBasic&articleId=78530
Here are some examples of how to compute internal rate of return using Microsoft Excel:
Microsoft Office Online, (n.d.) IRR, retrieved August 2008 from: https://office.microsoft.com/en-us/excel/HP052091461033.aspx
Advanced Excel Business Center, (2008), Internal rate of return, retrieved August 2009 from https://www.advanced-excel.com/internal_rate_of_return.html
For an example of the profitability index, see:
FinanceScholar.com, (n.d.). Profitability index – Investment rankings, retrieved August 200 8 from: https://www.financescholar.com/profitability-index.html
To gain a deeper understanding of capital budgeting beyond just the formulas, carefully review the following links:
Summary of Capital Budgeting. (n.d.) Summary of Capital Budgeting, Retrieved August 1, 2007 from:
https://www.studyfinance.com/lessons/capbudget/index.mv
Lefley, F. (1997). Modified internal rate of return: Will it replace IRR?. Management Accounting, 75(1), 64-65. Retrieved February
