FINANCIAL MANAGEMENT

Ameena Mohamed
6573
 Contents
• Introduction
• NPV
• IRR
• ARR
• Payback Period
• Benefits of corporate governance
• Conclusion
 Introduction

• U.S steel corporation is planning to invest in a special manufacturing system

to produce a new product.
• Conduct capital budgeting analysis for the project
• In order to evaluate the feasibility of the investment these are the thing have
done.
• Calculate WACC
• NPV, IRR ARR and payback period.
 Calculate WACC

discount rate to
project
find net present
evaluation in
value (NPV) of
business
cash flows.

sources of capital,
including common
stock, preferred
stock, bonds and any
other long-term debt
 WACC
• Capital Asset Pricing Model (CAPM) • Formula for WACC
• Calculation of Cost of Equity (Re):
• 𝑪𝒐𝒔𝒕 𝒐𝒇 𝒄𝒂𝒑𝒊𝒕𝒂𝒍 =
𝐸
𝑅𝐸 +
𝐷
𝑅𝑑 +
• The below CAPM formula can be useful to 𝑃
𝑅𝑝
𝑉 𝑉

compute cost of equity: 𝑉

• Re = RF + (RM – RF) * β • Calculation of Cost of Capital:

• Where, • Then, cost of capital will be:

• RF (Risk free rate) = 2% • 𝐶𝑜𝑠𝑡 𝑜𝑓 𝑐𝑎𝑝𝑖𝑡𝑎𝑙 =

60,000,000
100,000,000
11.3 +
• RM (Market return) = 5% 30,000,000
8+
10,000,000
9
100,000,000 100,000,000
• β (Beta coefficient of U.S steel Corps Beta)
• 𝐶𝑜𝑠𝑡 𝑜𝑓 𝑐𝑎𝑝𝑖𝑡𝑎𝑙 = 6.78 + 2.4 + 0.9
= 3.1
• Then, cost of equity will be:
• WACC =10.08%

• = 2% + (5% - 2%) * 3.1

• Common equity 11.3%
 Net Present value
• Preset value of net cash inflow = (148866*0.908) + (153331.22*0.825) + (157931.45*0.749)
+ (245226.33*0.681) => $546958.38
• NPV = Preset value of net cash inflow – initial outlay
• = $546958.38- $300,000
• $246958.38
• profitability of an investment.
• The NPV would be same if the values were same because it is an estimate of future cash
flows.
• It could be change only if different cost of capital is used.
PV factor
Project Net Cash Flow @10.08% Present Value
Year (A) (B) (A×B)
1 148866 0.908 148866*0.908 => 135170.33
2 153331.22 0.825 153331.22*0.825 => 126498.26
3 157931.45 0.749 157931.45*0.749 => 118290.66
4 245226.33 0.681 245226.33*0.681 => 166999.13
 Internal Rate of Return

• Internal Rate of Return = 𝐿𝐷𝑅 +

𝑃1− 𝐼𝑛𝑖𝑡𝑖𝑎𝑙 𝑂𝑢𝑡𝑙𝑎𝑦
𝑃1−𝑃2
∗ (𝐻𝐷𝑅 − 𝐿𝐷𝑅)

• Where:
• LDR = Lower discount rate = 10.08%
• HDR = Higher discount rate = 42%
• P1 = Present value at lower rate of interest = $546958.38
• P2 = Present value at higher rate of interest = $296,348.04

• Internal Rate of Return (U.S steel corporate) = 10.08 +

546958.38− 300000
546958.38−296348.04
∗ (42 − 10.08)

• = 41.53%
• IRR for this project is 41.53%
• . IRR could be different if the initial investment and cash flows are different.
• We want the IRR to be higher than the required rate of return to accept the project
• If IRR is greater than WACC,.
 Average rate of return

used in capital accounting to estimate whether to proceed with an investment

ARR Decision Rule: Take Projects with ARR's > Required Accounting
Rate; Reject Projects with ARR's < Required Accounting Rate
 Payback period
Payback Discount payback
 Benefits of Corporate Governance
• Strong corporate governance maintains investors’ confidence, as a result of
which, company can raise capital efficiently and effectively.
• It lowers the capital cost.
• There is a positive impact on the share price.
• It provides proper inducement to the owners as well as managers to achieve
objectives that are in interests of the shareholders and the organization.
• Good corporate governance also minimizes wastages, corruption, risks and
mismanagement.
• It helps in brand formation and development.
• It ensures organization in managed in a manner that fits the best interests of
all.
 Conclusion
• Techniques of capital budgeting assume that various investment suggestions
under deliberation are collectively exclusive which may not virtually be true
in some particular circumstances.
• It involve an estimate of future cash inflows and outflows.
• The NPV and the IRR approaches of selecting capital investment proposals
are closely related.
• IRR, NPV, and PI can lead to different decisions when they are used to rank
projects or to select between mutually exclusive projects.
• IRR and PI methods are not well suited to evaluating projects which vary in
scale.
• This case, U.S Steel Corp’s has higher NPV, higher IRR, and Higher ARR. So
it is accepted.
Thank you

Q&A