Week 39 (11.1.08)

Learn

1. Capital expenditure budgets cover projects that last over one year and initial costs are typically spread over the life of the project.


2. Operating budget address the day-to-day costs of the business which are expensed.


3. The sooner an organization receives cash, the greater the value of the cash to the organization. Since capital projects last over one year, it is important to consider the time value of money in evaluating them.


4. A project's payback is the time required to recover the investment in the project. Since payback does not consider cash flows after recovery, it should not be used to rank projects.


5. The hurdle rate is an organization's minimally acceptable rate of return on capital projects.


6. The net present value (NPV) of a project is its cash inflows discounted at the hurdle rate less the cash outflows.


7. A positive net present value indicates the project's rate of return exceeds the hurdle rate.


8. A net present value of zero indicates the projects's rate of return is the same as the hurdle rate.


9. A negative net present value indicates that the project's rate of return is less than the hurdle rate.


10. The internal rate of return (IRR) is the project's rate of return.


11. The profitability index (PI) is the project's cash inflows discounted at the hurdle rate divided by the cash outflows.


12. A profitability index greater than 1 indicates that the project's return exceeds the hurdle rate. Comparing profitability indexes is a good way to rank projects.

Unlearn

Nothing to unlearn as all informations are new learning.

Relearn

I do an imaginary Debt Financing:

Capital RM100,000

A. Saving of FD in bank for 10 yrs

100,000 x 3.5% x 10 = 35,000

Total return = 135,000 (aft 10 yrs)

B. Alternative to invest 600K shop house

Loan 500,000 from bank at BLR -1.5% for 25 yrs (BLR 6.75%- 1.5% = 5.25% annually)

Interest expense = 500,000 at 5.25% x 10 yrs = 262,500

Monthly repayment = 3,500 x 12 x 10 = 420,000

Total investment (aft 10 yrs) = 100K + 262.5K + 420K = 782.5K

After 10 yrs, assume shop house appreciation of 7% annually = 600K + (600K x 7%x 10) =1,020,000

Therefore, total return if property sold after 10 yrs = 1,020,000 - 782,500 = 237,500

In conclusion, with capital of RM100,000 - if invested in property with good assumption of appreciation, the Return on Equity (ROE) is higher with Debt Financing.