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Inter_P6A_FM_Mod2_Chapter_7_Investment_Decisions.pdf | FM | Study_Material | N/A | [Concept: Theory]
## ILLUSTRATION 6
A Ltd. is evaluating a project involving an outlay of ` 10,00,000 resulting in an annual cash inflow of ` 2,50,000 for 6 years. Assuming salvage value of the project is zero; DETERMINE the IRR of the project. | [
0.021115634590387344,
0.036569904536008835,
-0.009478961117565632,
-0.03127605468034744,
-0.01184876449406147,
-0.010449525900185108,
0.02352423407137394,
0.027591239660978317,
0.010706494562327862,
0.044577572494745255,
0.04563836008310318,
0.022709475830197334,
0.002805629512295127,
-0.0... |
Inter_P6A_FM_Mod2_Chapter_7_Investment_Decisions.pdf | FM | Study_Material | N/A | [Concept: Theory]
## SOLUTION
First of all, we shall find an approximation of the payback period:
<!-- formula-not-decoded -->
Now, we shall search this figure in the PVAF table corresponding to 6-year row.
The value 4 lies between values 4.111 and 3.998, correspondingly discounting rates are 12% and 13% respective... | [
0.005884447600692511,
0.04320923984050751,
-0.010509824380278587,
-0.0046694641932845116,
-0.022420892491936684,
-0.016245633363723755,
-0.004856823477894068,
0.0033278497867286205,
-0.008053415454924107,
0.07191190123558044,
0.05060265213251114,
0.012585225515067577,
0.015456082299351692,
... |
Inter_P6A_FM_Mod2_Chapter_7_Investment_Decisions.pdf | FM | Study_Material | N/A | [Concept: Theory]
## ILLUSTRATION 7
CALCULATE the internal rate of return of an investment of ` 1,36,000 which yields the following cash inflows:
| Year | Cash Inflows ( ` ) |
|--------|----------------------|
| 1 | 30,000 |
| 2 | 40,000 |
| 3 | 60,000 |
| ... | [
0.007229903247207403,
0.037103503942489624,
-0.012183094397187233,
-0.04980241507291794,
-0.02092590741813183,
-0.020398588851094246,
-0.0015116505092009902,
0.02605888433754444,
-0.007406705059111118,
0.06692488491535187,
0.038456693291664124,
0.055778034031391144,
-0.0005773925804533064,
... |
Inter_P6A_FM_Mod2_Chapter_7_Investment_Decisions.pdf | FM | Study_Material | N/A | [Concept: Theory]
## SOLUTION
Let us discount cash flows by 10%.
| Year | Cash Inflows (`) | Discounting factor at 10% | Present Value (`) |
|-----------------------------------|-----------------------------------|----------------------------------... | [
0.04469655454158783,
0.0458487831056118,
0.0029017303604632616,
-0.017185315489768982,
-0.02777700684964657,
-0.03239661082625389,
0.022783851251006126,
0.026377269998192787,
-0.0208760816603899,
0.06273318827152252,
0.02854250930249691,
0.014432216063141823,
0.03409991040825844,
0.0026012... |
Inter_P6A_FM_Mod2_Chapter_7_Investment_Decisions.pdf | FM | Study_Material | N/A | [Concept: Theory]
## FINANCIAL MANAGEMENT
The NPV calculated @ 10% is positive. Therefore, a higher discount rate is suggested, say, 12%.
| Year | Cash Inflows (`) | Discounting factor at 12% | Present Value (`) |
|--------------------------|--------------------------|-----... | [
0.030049581080675125,
0.036846790462732315,
-0.019113140180706978,
-0.029514925554394722,
-0.031003160402178764,
-0.03219059109687805,
0.03849389776587486,
0.015408617444336414,
-0.013345242477953434,
0.0588928684592247,
0.04103263467550278,
0.009171807207167149,
0.012932151556015015,
0.01... |
Inter_P6A_FM_Mod2_Chapter_7_Investment_Decisions.pdf | FM | Study_Material | N/A | [Concept: Theory]
## ILLUSTRATION 8
A company proposes to install machine involving a capital cost of ` 3,60,000. The life of the machine is 5 years and its salvage value at the end of the life is nil. The machine will produce the net operating income after depreciation of ` 68,000 per annum. The company's tax rate i... | [
0.019495543092489243,
0.025322601199150085,
-0.0035665547475218773,
-0.011116985231637955,
-0.017734937369823456,
-0.028953252360224724,
0.005076269153505564,
-0.009489345364272594,
-0.00967299472540617,
0.05940193682909012,
0.03173268586397171,
0.01197708211839199,
0.02256792038679123,
-0... |
Inter_P6A_FM_Mod2_Chapter_7_Investment_Decisions.pdf | FM | Study_Material | N/A | [Concept: Theory]
## Computation of Cash inflow per annum
`
| Particulars | ( ` ) |
|-------------------------------------------|----------|
| Net operating income per annum | 68,000 |
| Less: Tax @45% | (30,600) |
| Profit after tax ... | [
0.026829000562429428,
0.03326961398124695,
-0.035931866616010666,
-0.02672477252781391,
-0.01086060144007206,
-0.020045755431056023,
0.037554509937763214,
0.02641928754746914,
-0.00954944547265768,
0.05786791443824768,
0.0296481903642416,
0.029341718181967735,
0.0059292931109666824,
-0.037... |
Inter_P6A_FM_Mod2_Chapter_7_Investment_Decisions.pdf | FM | Study_Material | N/A | [Concept: Theory]
## Computation of Internal Rate of Return
| | Discounting Rate | Discounting Rate |
|-------------------|----------------------|--------------------|
| | 15% | 16% |
| Cumulative factor | 3.35 | 3.27 ... | [
0.03875406086444855,
0.02174919657409191,
-0.02720227837562561,
-0.00546357873827219,
-0.03521288186311722,
-0.030353857204318047,
0.01169747207313776,
0.009246190078556538,
-0.00440782867372036,
0.06563092768192291,
0.030043890699744225,
0.02218390256166458,
0.021389789879322052,
-0.03544... |
Inter_P6A_FM_Mod2_Chapter_7_Investment_Decisions.pdf | FM | Study_Material | N/A | [Concept: Theory]
## 9.3.1 Acceptance Rule
The use of IRR, as a criterion to accept capital investment decision involves a comparison of IRR with the required rate of return known as cut-off rate. The project should the accepted if IRR is greater than cut-off rate. If IRR is equal to cut- | [
0.0021072993986308575,
0.015757670626044273,
0.014337017200887203,
-0.006546291057020426,
-0.040374454110860825,
-0.012616497464478016,
0.013205792754888535,
0.012859588488936424,
-0.0037365644238889217,
0.051877718418836594,
0.0356132797896862,
0.029220404103398323,
-0.030640169978141785,
... |
Inter_P6A_FM_Mod2_Chapter_7_Investment_Decisions.pdf | FM | Study_Material | N/A | [Concept: Theory]
## FINANCIAL MANAGEMENT
off rate the firm is indifferent. If IRR less than cut off rate the project is rejected. Thus,
| If IRR ≥ Cut -off Rate or WACC | Accept the Proposal |
|----------------------------------|-----------------------|
| If IRR < Cut-off Rate or WACC | Reject the Proposal ... | [
0.013362908735871315,
0.026391878724098206,
-0.03634344041347504,
0.01753862388432026,
-0.009739920496940613,
-0.030100835487246513,
0.03380606323480606,
0.010335667990148067,
-0.002726699458435178,
0.0550743043422699,
0.031731098890304565,
0.018649816513061523,
-0.008322160691022873,
-0.0... |
Inter_P6A_FM_Mod2_Chapter_7_Investment_Decisions.pdf | FM | Study_Material | N/A | [Concept: Theory]
## 9.3.2 Internal Rate of Return (IRR) and Mutually Exclusive Projects
Projects are called mutually exclusive, when the selection of one precludes the selection of others e.g. in case a company owns a piece of land which can be put to use either for project S or L, such projects are mutual... | [
-0.016032511368393898,
0.03899065777659416,
-0.0028375217225402594,
-0.012060990557074547,
-0.02293524146080017,
-0.03016665019094944,
0.008729930967092514,
0.004115386866033077,
-0.01869056187570095,
0.0518188551068306,
0.041951149702072144,
0.02689259871840477,
0.003014956833794713,
-0.0... |
Inter_P6A_FM_Mod2_Chapter_7_Investment_Decisions.pdf | FM | Study_Material | N/A | [Concept: Theory]
## Cash flows
| | Year 0 | Year 1 | IRR | NPV at 10% |
|-----------|---------------|------------|-------|--------------|
| Project A | ( ` 1,00,000) | ` 1,50,000 | 50% | ` 36,360 |
| Project B | ( ` 5,00,000) | ` 6,25,000 | 25% | ` 68,180 |
Project A earns a retu... | [
0.01087744627147913,
0.03930367901921272,
0.004133468493819237,
-0.009436977095901966,
-0.035966694355010986,
-0.04274958372116089,
-0.0053252894431352615,
0.013658426702022552,
-0.029245959594845772,
0.05305567756295204,
0.03791079670190811,
0.037788521498441696,
0.015291405841708183,
0.0... |
Inter_P6A_FM_Mod2_Chapter_7_Investment_Decisions.pdf | FM | Study_Material | N/A | [Concept: Theory]
## Example- 9
| Year | Project A | Project B |
|--------|-------------|-------------|
| | (`) | (`) |
| 0 | (9,00,000) | (8,00,000) |
| 1 | 7,00,000 | 62,500 |
| 2 | 6,00,000 | 6,00,000 |
| 3 | 4,00,000 | 6,00,000 |
| 4 | 50,... | [
0.03877997770905495,
0.024206984788179398,
-0.0009035106049850583,
0.002910315990447998,
-0.03232968971133232,
-0.044401299208402634,
0.011314895004034042,
0.0023810076527297497,
-0.0033617776352912188,
0.0671667829155922,
0.015223510563373566,
0.004398923367261887,
0.03208130970597267,
0.... |
Inter_P6A_FM_Mod2_Chapter_7_Investment_Decisions.pdf | FM | Study_Material | N/A | [Concept: Theory]
## FINANCIAL MANAGEMENT
In this case, Project A has the larger investment and also has a higher IRR as shown below,
| Year | (`) | r = 46% | PV (`) | (`) | r = 35% | PV (`) |
|------... | [
0.03102807328104973,
0.021053778007626534,
-0.015532739460468292,
-0.005134011153131723,
-0.04180212691426277,
-0.034219805151224136,
0.018392596393823624,
-0.01776847057044506,
-0.0019869571551680565,
0.05746958777308464,
0.035918429493904114,
0.015772085636854172,
0.008558054454624653,
-... |
Inter_P6A_FM_Mod2_Chapter_7_Investment_Decisions.pdf | FM | Study_Material | N/A | [Concept: Theory]
## 9.3.3 The Reinvestment Assumption
The Net Present Value technique assumes that all cash flows can be reinvested at the discount rate used for calculating the NPV. This is a logical assumption since
1.41
the use of the NPV technique implies that all projects which provide a higher return than the... | [
-0.01089638751000166,
0.04056767374277115,
0.006024688947945833,
-0.05098459869623184,
-0.04525156319141388,
-0.015329320915043354,
-0.0005814333562739193,
-0.040187444537878036,
-0.0227874256670475,
0.04999173432588577,
0.03024188242852688,
-0.020178260281682014,
0.028831427916884422,
-0.... |
Inter_P6A_FM_Mod2_Chapter_7_Investment_Decisions.pdf | FM | Study_Material | N/A | [Concept: Theory]
## 9.3.4 Multiple Internal Rate of Return
In cases, where project cash flows change signs or reverse during the life of a project e.g. an initial cash outflow is followed by cash inflows and subsequently followed by a major cash outflow, there may be more than one IRR. The following gra... | [
0.012586339376866817,
0.030836986377835274,
-0.01514704991132021,
-0.04098008945584297,
-0.04225009307265282,
-0.04189146310091019,
0.007818680256605148,
0.008131412789225578,
-0.007602029014378786,
0.09002223610877991,
0.036805737763643265,
0.01755417510867119,
-0.004833906423300505,
-0.0... |
Inter_P6A_FM_Mod2_Chapter_7_Investment_Decisions.pdf | FM | Study_Material | N/A | [Concept: Theory]
## Limitations of IRR
- The calculation process is tedious if there is more than one cash outflow interspersed between the cash inflows; there can be multiple IRR, the interpretation of which is difficult.
- The IRR approach creates a peculiar situation if we compare two projects wit... | [
0.015947416424751282,
0.029947148635983467,
-0.01017528586089611,
-0.01512525137513876,
-0.033342499285936356,
-0.00959341786801815,
-0.0024242105428129435,
-0.004179390147328377,
-0.01566610112786293,
0.07535846531391144,
0.013210351578891277,
0.013901596888899803,
-0.016086237505078316,
... |
Inter_P6A_FM_Mod2_Chapter_7_Investment_Decisions.pdf | FM | Study_Material | N/A | [Concept: Theory]
## 9.4 Discounted Payback Period Method
This is similar to Payback period as discussed in 8.1 under the non-discounting method except that the cash flows here are discounted at predetermined rate and the payback period so calculated is called Discounted payback period . One of the most p... | [
0.008375863544642925,
0.03264699876308441,
-0.004886005073785782,
0.007749213371425867,
-0.04372970014810562,
-0.02660253271460533,
-0.03275398164987564,
-0.04102656990289688,
-0.03167276829481125,
0.07131925225257874,
0.016408056020736694,
0.013694880530238152,
0.018885526806116104,
-0.03... |
Inter_P6A_FM_Mod2_Chapter_7_Investment_Decisions.pdf | FM | Study_Material | N/A | [Concept: Theory]
## INVESTMENT DECISIONS
The problem with the Payback Period is that it ignores the time value of money. In order to correct this, we can use discounted cash flows in calculating the payback period. Referring back to our example, if we discount the cash inflows at 15% required rate of ret... | [
0.030837051570415497,
0.05270169675350189,
0.0025051510892808437,
0.017491573467850685,
-0.03948463499546051,
-0.024416303262114525,
-0.01000415999442339,
-0.02376764826476574,
-0.010540188290178776,
0.06543096154928207,
0.010956646874547005,
0.018014276400208473,
0.020722052082419395,
0.0... |
Inter_P6A_FM_Mod2_Chapter_7_Investment_Decisions.pdf | FM | Study_Material | N/A | [Concept: Theory]
## 9.5 Modified Internal Rate of Return (MIRR)
As mentioned earlier, there are several limitations attached with the concept of the conventional Internal Rate of Return (IRR). The MIRR addresses some of these deficiencies e.g., it eliminates multiple IRR rates; it addresses the rei... | [
0.0019724825397133827,
0.0015273505123332143,
-0.0028999459464102983,
-0.04844585806131363,
-0.01815800741314888,
-0.021100111305713654,
0.005413595121353865,
-0.021374057978391647,
-0.016753224655985832,
0.061529625207185745,
0.0060930512845516205,
0.027118634432554245,
-0.00819079857319593... |
Inter_P6A_FM_Mod2_Chapter_7_Investment_Decisions.pdf | FM | Study_Material | N/A | [Concept: Theory]
## ILLUSTRATION 9
An investment of ` 1,36,000 yields the following cash inflows (profits before depreciation but after tax). DETERMINE MIRR considering 8% as cost of capital.
| Year | (`) |
|--------|----------|
| 1 | 30,000 |
| 2 | 40,000 |
| 3 | 60,000 |
| 4 ... | [
-0.006247560493648052,
0.03523051738739014,
-0.0008818806381896138,
-0.05352345108985901,
0.022937798872590065,
-0.012046681717038155,
0.0028849842492491007,
0.003582543460652232,
-0.0008933648932725191,
0.06621333956718445,
0.033496953547000885,
0.04277089983224869,
-0.0009419280686415732,
... |
Inter_P6A_FM_Mod2_Chapter_7_Investment_Decisions.pdf | FM | Study_Material | N/A | [Concept: Theory]
## SOLUTION
Year 0 - Cash outflow = ` 1,36,000
The MIRR is calculated on the basis of investing the inflows at the cost of capital. The table below shows the value of the inflows, if they are immediately reinvested at 8%.
| Year | Cash flow | @8% reinvestment rate factor | (`) |
|-------... | [
0.007115749642252922,
0.02574116177856922,
0.0028909326065331697,
-0.03328585624694824,
-0.0034639346413314342,
-0.025052988901734352,
0.02386133186519146,
0.003538810880854726,
-0.021715758368372917,
0.05208295211195946,
0.02153198979794979,
0.034823644906282425,
-0.004773739725351334,
-0... |
Inter_P6A_FM_Mod2_Chapter_7_Investment_Decisions.pdf | FM | Study_Material | N/A | [Concept: Theory]
## INVESTMENT DECISIONS
The total cash outflow in year 0 ( ` 1,36,000) is compared with the possible inflow at year 5 and the resulting figure = 2,13,587 1,36,000 = 0.6367 is the discount factor in year
5. By looking at the year 5 row in the present value tables, you will see that this gives a retu... | [
0.005225269123911858,
0.02435888908803463,
-0.001167977461591363,
-0.020486723631620407,
-0.0010058191837742925,
-0.01879253424704075,
0.024173464626073837,
0.0014253673143684864,
-0.026937521994113922,
0.07859410345554352,
0.02636035904288292,
0.01222891267389059,
-0.017311658710241318,
0... |
Inter_P6A_FM_Mod2_Chapter_7_Investment_Decisions.pdf | FM | Study_Material | N/A | [Concept: Theory]
## Similarity
- Both the net present value (NPV) and the internal rate of return (IRR) methods are discounted cash flow methods which consider the time value of money.
- Both the techniques consider all cash flows over the expected useful life of the investment. | [
-0.013607459142804146,
0.026124756783246994,
-0.005660839378833771,
-0.049550797790288925,
-0.030759941786527634,
-0.026634367182850838,
0.006230369210243225,
-0.03464817255735397,
-0.009671179577708244,
0.04695591703057289,
0.014256006106734276,
0.019251495599746704,
0.024922765791416168,
... |
Inter_P6A_FM_Mod2_Chapter_7_Investment_Decisions.pdf | FM | Study_Material | N/A | [Concept: Theory]
## Scenario 1 - Scale or Size Disparity
Being IRR a relative measure and NPV an absolute measure in case of disparity in scale or size both may give contradicting ranking. This can be understood with the help of following illustration: | [
0.017091169953346252,
-0.009025358594954014,
0.005586961749941111,
-0.015416818670928478,
-0.017432017251849174,
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0.01519054640084505,
0.01029343530535698,
-0.014423021115362644,
0.063577800989151,
0.02569933794438839,
-0.017007792368531227,
0.0222608782351017,
-0.006... |
Inter_P6A_FM_Mod2_Chapter_7_Investment_Decisions.pdf | FM | Study_Material | N/A | [Concept: Theory]
## ILLUSTRATION 10
Suppose there are two Project A and Project B are under consideration. The cash flows associated with these projects are as follows:
| Year | Project A ( ` ) | Project B ( ` ) |
|--------|-------------------|-------------------|
| 0 | (1,00,000) | (3,00,000) ... | [
0.01892884261906147,
0.043589163571596146,
-0.0127569530159235,
-0.018598563969135284,
-0.04442095384001732,
-0.02851489931344986,
0.001832119538448751,
0.011346009559929371,
-0.014936630614101887,
0.05909424275159836,
0.02434709668159485,
0.02137274295091629,
0.021488185971975327,
-0.0180... |
Inter_P6A_FM_Mod2_Chapter_7_Investment_Decisions.pdf | FM | Study_Material | N/A | [Concept: Theory]
## Net Present Value (NPV) of Projects
| Year | Cash Inflows of Project A (`) | Cash Inflows of Project B (`) | Present Value Factor@ 10% | PV of Project A (`) | PV of Project B (`) |
|--------|---------------------------------|---------------------------------|---------------------------... | [
0.031441830098629,
0.050253018736839294,
-0.002111276611685753,
-0.0008183089666999876,
-0.04542265459895134,
-0.05453966557979584,
0.02068520151078701,
0.0117564732208848,
-0.008979486301541328,
0.06705415993928909,
0.015498089604079723,
0.009747001342475414,
0.05797693133354187,
-0.02381... |
Inter_P6A_FM_Mod2_Chapter_7_Investment_Decisions.pdf | FM | Study_Material | N/A | [Concept: Theory]
## Internal Rate of Returns (IRR) of projects
Since by discounting cash flows at 10%, we are getting values very far from zero. Therefore, let us discount cash flows using 20% discounting rate.
| Year | Cash Inflows of Project A (`) | Cash Inflows of Project B (`) | Present Value Factor@ 20% ... | [
0.025891471654176712,
0.03200912103056908,
-0.012375053018331528,
-0.03200990706682205,
-0.056107185781002045,
-0.036782827228307724,
0.014416562393307686,
0.006325815338641405,
-0.021872540935873985,
0.06791894137859344,
0.015463598072528839,
0.025623008608818054,
0.020394789054989815,
-0... |
Inter_P6A_FM_Mod2_Chapter_7_Investment_Decisions.pdf | FM | Study_Material | N/A | [Concept: Theory]
## INVESTMENT DECISIONS
Even by discounting cash flows at 20%, we are getting values far from zero. Therefore, let us discount cash flows using 25% discounting rate.
| Year | Cash Inflows of Project A (`) | Cash Inflows of Project B (`) | Present Value Factor@ 25% | PV of Projec... | [
0.024858638644218445,
0.026468344032764435,
-0.0174348633736372,
-0.010564392432570457,
-0.05756391957402229,
-0.026347531005740166,
0.025148147717118263,
0.0058263856917619705,
-0.009990799240767956,
0.08488982170820236,
0.019464466720819473,
0.007496098522096872,
0.021387707442045212,
0.... |
Inter_P6A_FM_Mod2_Chapter_7_Investment_Decisions.pdf | FM | Study_Material | N/A | [Concept: Theory]
## Scenario 2 - Time Disparity in Cash Flows
It might be possible that overall cash flows may be more or less same in the projects but there may be disparity in their flows i.e. larger part of cash inflows may be occurred in the beginning or end of the project. In such situation there may be dif... | [
0.031050512567162514,
0.05457405373454094,
-0.035638079047203064,
-0.016843654215335846,
-0.0064458344131708145,
-0.03073754534125328,
-0.026692792773246765,
0.008197680115699768,
-0.007514670491218567,
0.08461564034223557,
0.00875142216682434,
0.01761435717344284,
0.034502435475587845,
-0... |
Inter_P6A_FM_Mod2_Chapter_7_Investment_Decisions.pdf | FM | Study_Material | N/A | [Concept: Theory]
## ILLUSTRATION 11
Suppose ABC Ltd. is considering two Project X and Project Y for investment. The cash flows associated with these projects are as follows:
| Year | Project X (`) | Project Y (`) |
|--------|-----------------|-----------------|
| 0 | (2,50,000) | (3,00,000) |
| ... | [
0.03042108751833439,
0.05040190368890762,
0.0008764836238697171,
-0.028590893372893333,
-0.029429985210299492,
-0.027292747050523758,
0.00845135934650898,
0.009813345968723297,
-0.0075280992314219475,
0.06548462808132172,
0.035267025232315063,
0.013809654861688614,
0.009368826635181904,
-0... |
Inter_P6A_FM_Mod2_Chapter_7_Investment_Decisions.pdf | FM | Study_Material | N/A | [Concept: Theory]
## Net Present Value of Projects
| Year | Cash Inflows of Project X (`) | Cash Inflows of Project Y (`) | Present Value Factor@ 10% | PV of Project X (`) | PV of Project Y (`) |
|--------|---------------------------------|---------------------------------|-----------------------------|---... | [
0.02883831225335598,
0.04718912020325661,
0.0006335387588478625,
-0.0033510765060782433,
-0.03841238468885422,
-0.05054591968655586,
0.015330321155488491,
0.014756432734429836,
0.0026853568851947784,
0.05791975557804108,
0.024306805804371834,
0.003253066912293434,
0.063178651034832,
-0.020... |
Inter_P6A_FM_Mod2_Chapter_7_Investment_Decisions.pdf | FM | Study_Material | N/A | [Concept: Theory]
## Internal Rate of Returns of projects
Since, by discounting cash flows at 10%, we are getting values far from zero. Therefore, let us discount cash flows using 20% discounting rate.
| Year | Cash Inflows of Project X (`) | Cash Inflows of Project Y (`) | Present Value Factor @20... | [
0.026295937597751617,
0.03251812234520912,
-0.008261173032224178,
-0.031353097409009933,
-0.05109870433807373,
-0.03560831770300865,
0.006858678534626961,
0.014800828881561756,
-0.011981895193457603,
0.06408970803022385,
0.01899711601436138,
0.023001478984951973,
0.030823396518826485,
-0.0... |
Inter_P6A_FM_Mod2_Chapter_7_Investment_Decisions.pdf | FM | Study_Material | N/A | [Concept: Theory]
## INVESTMENT DECISIONS
Since, by discounting cash flows at 20% we are getting that value of Project X is positive and value of Project Y is negative. Therefore, let us discount cash flows of Project X using 25% discounting rate and Project Y using discount rate of 15%.
| Year | Cash Inflows of Pr... | [
0.025330763310194016,
0.023311583325266838,
-0.0017441670643165708,
-0.019449274986982346,
-0.0525546669960022,
-0.019438810646533966,
0.017079530283808708,
0.01266565453261137,
0.0002598016581032425,
0.08138963580131531,
0.026295773684978485,
0.007951391860842705,
0.030892986804246902,
-0... |
Inter_P6A_FM_Mod2_Chapter_7_Investment_Decisions.pdf | FM | Study_Material | N/A | [Concept: Theory]
## ILLUSTRATION 12
Suppose MVA Ltd. is considering two Project A and Project B for investment. The cash flows associated with these projects are as follows:
| Year | Project A (`) | Project B (`) |
|--------|-----------------|-----------------|
| 0 | (5,00,000) | (5,00,000) |
| ... | [
0.0036492899525910616,
0.032525163143873215,
-0.017670605331659317,
-0.02311435155570507,
-0.036385174840688705,
-0.027486853301525116,
0.005693091079592705,
0.0032981124240905046,
-0.020954223349690437,
0.06533943861722946,
0.016721058636903763,
0.033478450030088425,
0.011602677404880524,
... |
Inter_P6A_FM_Mod2_Chapter_7_Investment_Decisions.pdf | FM | Study_Material | N/A | [Concept: Theory]
## Net Present Value of Projects
| Year | Cash Inflows of Project A (`) | Cash Inflows of Project B (`) | Present Value Factor @12% | PV of Project A (`) | PV of Project B (`) |
|--------|---------------------------------|---------------------------------|-----------------------------|---... | [
0.02454952709376812,
0.04411466419696808,
-0.0008308336837217212,
-0.0022946016397327185,
-0.053890399634838104,
-0.048348214477300644,
0.011154983192682266,
0.005281792487949133,
-0.0037091937847435474,
0.06817460060119629,
0.01852564327418804,
0.00598374055698514,
0.05530102178454399,
-0... |
Inter_P6A_FM_Mod2_Chapter_7_Investment_Decisions.pdf | FM | Study_Material | N/A | [Concept: Theory]
## Internal Rate of Returns of projects
Let us discount cash flows using 50% discounting rate.
| Year | Cash Inflows of Project A (`) | Cash Inflows of Project B (`) | Present Value Factor@ 50% | PV of Project A (`) | PV of Project B (`) |
|--------|---------------------------------|----... | [
0.016723794862627983,
0.03329719975590706,
-0.01469439547508955,
-0.023396529257297516,
-0.07195767015218735,
-0.03567329794168472,
0.004459989722818136,
0.002899774583056569,
-0.008173135109245777,
0.06619077175855637,
0.013949647545814514,
0.028414161875844002,
0.030647115781903267,
-0.0... |
Inter_P6A_FM_Mod2_Chapter_7_Investment_Decisions.pdf | FM | Study_Material | N/A | [Concept: Theory]
## FINANCIAL MANAGEMENT
1.51
| 1 | 7,50,000 | 2,00,000 | 0.667 | 5,00,250 | 1,33,400 |
|-----|------------|------------|---------|------------|------------|
| 2 | 0 | 2,00,000 | 0.444 | 0 | 88,800 |
| 3 | 0 | 7,00,000 | 0.296 | 0 | 2,07... | [
0.03602898120880127,
0.022771291434764862,
-0.018085023388266563,
-0.00024058787676040083,
-0.05965973064303398,
-0.028192970901727676,
0.024454470723867416,
-0.00658629322424531,
-0.016489919275045395,
0.0793478786945343,
0.038362208753824234,
0.0029258078429847956,
0.017372872680425644,
... |
Inter_P6A_FM_Mod2_Chapter_7_Investment_Decisions.pdf | FM | Study_Material | N/A | [Concept: Theory]
## Overall Position
| | Project A | Project B |
|----------|-------------|-------------|
| NPV @12% | ` 1,69,750 | ` 3,36,400 |
| IRR | 50.00% | 43.07% |
Thus, there is contradiction in ranking by two methods.
<!-- image --> | [
0.02111745811998844,
-0.0009092364925891161,
-0.04102475196123123,
0.0026470161974430084,
-0.03916628658771515,
-0.032618097960948944,
0.023084793239831924,
0.01758328080177307,
0.0192905031144619,
0.05796876922249794,
0.022326305508613586,
-0.019456977024674416,
0.03531404212117195,
-0.02... |
Inter_P6A_FM_Mod2_Chapter_7_Investment_Decisions.pdf | FM | Study_Material | N/A | [Concept: Theory]
## 10. SUMMARY OF DECISION CRITERIA OF CAPITAL BUDGETING TECHNIQUES
| Techniques | Techniques | For Independent Project | For Independent Project | For Mutually Exc... | [
0.037889353930950165,
0.02010764554142952,
0.010540947318077087,
-0.006996115203946829,
-0.053375791758298874,
-0.04183634743094444,
-0.0030985441990196705,
0.011559111066162586,
-0.01230284571647644,
0.05425281077623367,
0.045485079288482666,
0.008380917832255363,
0.031029144302010536,
-0... |
Inter_P6A_FM_Mod2_Chapter_7_Investment_Decisions.pdf | FM | Study_Material | N/A | [Concept: Theory]
## 11.1 Capital Budgeting under Capital Rationing
As discussed earlier, if project has positive NPV, it should be accepted with an objective of maximisation of wealth of shareholders. However, there may be a situation due to resource (capital) constraints (rationing) a firm ma... | [
0.034499023109674454,
0.03258250281214714,
-0.005561476107686758,
-0.016677958890795708,
-0.03950749337673187,
-0.03812041133642197,
-0.0037260260432958603,
0.0206045750528574,
-0.017966989427804947,
0.07518693059682846,
0.02563953399658203,
-0.014022484421730042,
0.029006274417042732,
-0.... |
Inter_P6A_FM_Mod2_Chapter_7_Investment_Decisions.pdf | FM | Study_Material | N/A | [Concept: Theory]
## ILLUSTRATION 13
Shiva Limited is planning its capital investment programme for next year. It has five projects all of which give a positive NPV at the company cut-off rate of 15 percent, the investment outflows and present values being as follows:
| Project | Investment (`) | NPV @15% (`) |... | [
0.0308491513133049,
0.037501201033592224,
-0.010996581986546516,
0.005767815746366978,
-0.03337213024497032,
-0.033717669546604156,
0.030891286209225655,
0.020521825179457664,
-0.0001482547086197883,
0.0537220723927021,
0.034048862755298615,
0.03725313022732735,
0.024464629590511322,
-0.01... |
Inter_P6A_FM_Mod2_Chapter_7_Investment_Decisions.pdf | FM | Study_Material | N/A | [Concept: Theory]
## Computation of NPVs per ` 1 of Investment and Ranking of the Projects
| Project | Investment | NPV @15% | NPV per ` 1 invested | Ranking |
|-----------|--------------|------------|------------------------|-----------|
| Project | ` '000 | ` '000 | | ... | [
0.030260931700468063,
0.03202049061655998,
-0.023082446306943893,
0.003552232403308153,
-0.03318123519420624,
-0.046106718480587006,
0.011981578543782234,
0.01938813365995884,
-0.0001059389251167886,
0.05125578120350838,
0.00556780444458127,
-0.0004807643126696348,
0.042120497673749924,
-0... |
Inter_P6A_FM_Mod2_Chapter_7_Investment_Decisions.pdf | FM | Study_Material | N/A | [Concept: Theory]
## Building up of a Programme of Projects based on their Rankings
(2/3 of project total)
| Project | Investment | NPV @15% |
|-----------|--------------|------------|
| Project | ` 000 | ` 000 |
| E | (35) | 19.3 |
| B | (40) | 18.7 |
|... | [
0.021240437403321266,
0.006040321663022041,
-0.0023498814553022385,
-0.01581387035548687,
-0.03840344399213791,
-0.036259278655052185,
0.013137919828295708,
0.034187424927949905,
-0.0032044011168181896,
0.059468746185302734,
0.02332904003560543,
0.010028714314103127,
0.060576945543289185,
... |
Inter_P6A_FM_Mod2_Chapter_7_Investment_Decisions.pdf | FM | Study_Material | N/A | [Concept: Theory]
## INVESTMENT DECISIONS
- (ii) Choosing one proposal among two proposals ( Mutually Exclusive ).
Although, while evaluating the proposals in the above scenarios, do not pose any special problem if they have same life period. But problem arises in case projects have unequal lives. In such situations ... | [
0.008819685317575932,
0.026738176122307777,
0.0026493396144360304,
-0.032919567078351974,
-0.05168842524290085,
-0.009885670617222786,
-0.035649366676807404,
0.008291133679449558,
0.023465516045689583,
0.06827005743980408,
0.039599813520908356,
-0.00761055015027523,
0.025805942714214325,
-... |
Inter_P6A_FM_Mod2_Chapter_7_Investment_Decisions.pdf | FM | Study_Material | N/A | [Concept: Theory]
## ILLUSTRATION 14
R Pvt. Ltd. is considering modernizing its production facilities and it has two proposals under consideration. The expected cash flows associated with these projects and their NPV as per discounting rate of 12% and IRR is as follows:
| Year | Cash Flow | Cash Flow |
|-... | [
0.03002087213099003,
0.02920163795351982,
-0.023202745243906975,
-0.00016271065396722406,
-0.06242541968822479,
-0.044581834226846695,
0.027971375733613968,
0.006143796723335981,
-0.04113820940256119,
0.06418878585100174,
0.03628186881542206,
0.032315898686647415,
0.03539569675922394,
0.00... |
Inter_P6A_FM_Mod2_Chapter_7_Investment_Decisions.pdf | FM | Study_Material | N/A | [Concept: Theory]
## SOLUTION
Although from NPV point of view, Project A appears to be better but from IRR point of view, Project B appears to be better. Since, both projects have unequal lives, selection on the basis of these two methods shall not be proper. In such situation, we shall use any of the following method... | [
0.015923913568258286,
-0.00027640737243928015,
-0.01337165292352438,
-0.017321066930890083,
-0.06983928382396698,
-0.041306059807538986,
-0.008643794804811478,
0.012989568524062634,
-0.0016737458063289523,
0.045737411826848984,
0.01938294619321823,
-0.02683824673295021,
0.04139382019639015,
... |
Inter_P6A_FM_Mod2_Chapter_7_Investment_Decisions.pdf | FM | Study_Material | N/A | [Concept: Theory]
## FINANCIAL MANAGEMENT
- (i) Replacement Chain (Common Life) Method: Since the life of the Project A is 6 years and Project B is 3 years, to equalize lives, we can have second opportunity of investing in project B after one time investing. The position of cash flows in such situation shall be as fol... | [
0.030404208227992058,
0.03220432251691818,
-0.0019422678742557764,
0.006581220310181379,
-0.03475138545036316,
-0.01283232867717743,
0.0028106190729886293,
-0.005630965810269117,
0.0207835640758276,
0.04358358308672905,
0.04540463164448738,
-0.013437003828585148,
0.031247681006789207,
-0.0... |
Inter_P6A_FM_Mod2_Chapter_7_Investment_Decisions.pdf | FM | Study_Material | N/A | [Concept: Theory]
## ILLUSTRATION 15
Alpha Company is considering the following investment projects:
| | Cash Flows ( ` ) | Cash Flows ( ` ) | Cash Flows ( ` ) | Cash Flows ( ` ) |
|----------|--------------------|--------------------|--------------------|--------------------|
| Projects | C 0 ... | [
0.04655145853757858,
0.06021641194820404,
-0.006476672366261482,
-0.002370002679526806,
-0.06917712837457657,
-0.02430647984147072,
0.00295072328299284,
0.01904159225523472,
-0.019011972472071648,
0.05589968338608742,
0.023922108113765717,
0.04597270116209984,
0.02943953312933445,
-0.00103... |
Inter_P6A_FM_Mod2_Chapter_7_Investment_Decisions.pdf | FM | Study_Material | N/A | [Concept: Theory]
## (iii) IRR
| Project A: | The net cash proceeds in year 1 are just equal to investment. Therefore, r = 0%. ... | [
0.029772767797112465,
0.044569049030542374,
-0.00975776743143797,
-0.016729988157749176,
-0.058709945529699326,
-0.021238282322883606,
-0.0013146380661055446,
0.004018808249384165,
-0.005686101038008928,
0.053082775324583054,
0.03505291789770126,
0.01348084770143032,
0.03552933782339096,
-... |
Inter_P6A_FM_Mod2_Chapter_7_Investment_Decisions.pdf | FM | Study_Material | N/A | [Concept: Theory]
## (iv) NPV
```
Project A: at 10% -10,000+10,000×0.909 = -910 at 30% -10,000+10,000×0.769 = -2,310 Project B: at 10% -10,000+7,500(0.909+0.826) = +3,013 at 30% -10,000+7,500(0.769+0.592) = +208 Project C: at 10% -10,000+2,000×0.909+4,000×0.826+12,000×0.751= +4,134 at 30% -10,000+2,000×0.769+4,000×0.5... | [
0.046132586896419525,
0.04092348366975784,
-0.015352771617472172,
0.0002139399730367586,
-0.03870266675949097,
-0.05859393998980522,
0.02081424742937088,
0.014683851972222328,
-0.023629970848560333,
0.05068980157375336,
0.025911523029208183,
0.002397428033873439,
0.03739539161324501,
-0.02... |
Inter_P6A_FM_Mod2_Chapter_7_Investment_Decisions.pdf | FM | Study_Material | N/A | [Concept: Theory]
## The projects are ranked as follows according to the various methods:
| Projects | PBP | ARR | IRR | NPV (10%) | NPV (30%) |
|------------|-------|-------|-------|-------------|-------------|
| A | 1 | 4 | 4 | 4 | 4 |
| B | 2 | 2... | [
0.01598815992474556,
0.037641894072294235,
-0.0028235625941306353,
-0.004001017194241285,
-0.05250027775764465,
-0.02532961033284664,
-0.014271683059632778,
0.005875800736248493,
-0.0035318206064403057,
0.057308752089738846,
0.025248225778341293,
-0.0034011423122137785,
0.035346854478120804,... |
Inter_P6A_FM_Mod2_Chapter_7_Investment_Decisions.pdf | FM | Study_Material | N/A | [Concept: Theory]
## ILLUSTRATION 16
The expected cash flows of three projects are given below. The cost of capital is 10 per cent.
- (a) CALCULATE the payback period, net present value, internal rate of return and accounting rate of return of each project.
- (b) IDENTIFY the rankings of the projects by each of the f... | [
0.005188922863453627,
0.04682643711566925,
-0.012669362127780914,
-0.04474857077002525,
-0.03299954533576965,
-0.025198722258210182,
-0.007461982779204845,
0.008774958550930023,
0.013524404726922512,
0.032889727503061295,
0.02918277680873871,
0.027980247512459755,
0.009337634779512882,
-0.... |
Inter_P6A_FM_Mod2_Chapter_7_Investment_Decisions.pdf | FM | Study_Material | N/A | [Concept: Theory]
## FINANCIAL MANAGEMENT
( ` in '000)
| Period | Project A (`) | Project B (`) | Project C (`) |
|----------|-----------------|-----------------|-----------------|
| 0 | (5,000) | (5,000) | (5,000) |
| 1 | 900 | 700 | 2,000 ... | [
0.05650512874126434,
0.0057671391405165195,
-0.0007553187315352261,
0.029005561023950577,
-0.04984941706061363,
-0.029859542846679688,
0.0055405860766768456,
-0.003040796611458063,
-0.006846364587545395,
0.06260734051465988,
0.027340620756149292,
0.008684626780450344,
0.022261252626776695,
... |
Inter_P6A_FM_Mod2_Chapter_7_Investment_Decisions.pdf | FM | Study_Material | N/A | [Concept: Theory]
## Net Present Value Method:
<!-- formula-not-decoded -->
NPVB is calculated as follows:
| Year | Cash flow (`) | 10% discount factor | Present value (`) |
|--------|-----------------|-----------------------|---------------------|
| 0 | (5000) | 1.000 | (5,000)... | [
0.03063305653631687,
0.02154827117919922,
-0.014063525013625622,
0.013976399786770344,
-0.02737445756793022,
-0.042597342282533646,
0.051658324897289276,
0.012658637948334217,
0.014422309584915638,
0.04314524680376053,
0.04241756349802017,
0.0000853596575325355,
0.05627146363258362,
0.0007... |
Inter_P6A_FM_Mod2_Chapter_7_Investment_Decisions.pdf | FM | Study_Material | N/A | [Concept: Theory]
## INVESTMENT DECISIONS
1.61
| 5 | 1100 | 0.621 | 683 |
|-----|--------|---------|-------|
| 6 | 1200 | 0.564 | 677 |
| 7 | 1300 | 0.513 | 667 |
| 8 | 1400 | 0.467 | 654 |
| 9 | 1500 | 0.424 | 636 |
| 10 | 1600 | 0.386 | 618 |
| | | |... | [
0.028718460351228714,
0.024629373103380203,
-0.0018414149526506662,
-0.005915144458413124,
-0.031206950545310974,
-0.033815931528806686,
0.04619095101952553,
0.023002270609140396,
0.0129757234826684,
0.04425765573978424,
0.03322859853506088,
-0.003914997912943363,
0.024392537772655487,
0.0... |
Inter_P6A_FM_Mod2_Chapter_7_Investment_Decisions.pdf | FM | Study_Material | N/A | [Concept: Theory]
## Project B
IRRB
| Year | Cash flow (`) | 10% discount factor | Present value (`) | 16% discount factor | Present value (`) |
|--------|-----------------|-----------------------|---------------------|-----------------------|---------------------|
| 0 | (5,000) | 1.000 ... | [
0.047484174370765686,
0.02065914310514927,
-0.004564929753541946,
-0.002724017947912216,
-0.027296224609017372,
-0.022216880694031715,
0.02254299819469452,
0.009197191335260868,
-0.011832878924906254,
0.06884422153234482,
0.028610022738575935,
0.001806612010113895,
0.02163047343492508,
-0.... |
Inter_P6A_FM_Mod2_Chapter_7_Investment_Decisions.pdf | FM | Study_Material | N/A | [Concept: Theory]
## IRRC
| Year | Cash flow (`) | 15% discount factor | Present value (`) | 18% discount factor | Present value (`) |
|--------|-----------------|-----------------------|---------------------|-----------------------|---------------------|
| 0 | (5,000) | 1.000 ... | [
0.02756066992878914,
0.007774484343826771,
-0.0013482454232871532,
-0.002929133828729391,
-0.03667762503027916,
-0.030790239572525024,
0.04340361803770065,
-0.011378701776266098,
-0.015300266444683075,
0.0710245668888092,
0.04249315336346626,
0.012074298225343227,
0.020964670926332474,
-0.... |
Inter_P6A_FM_Mod2_Chapter_7_Investment_Decisions.pdf | FM | Study_Material | N/A | [Concept: Theory]
## (b) Summary of Results
| | A | B | C |
|-----------------|--------|-------|-------|
| Payback (years) | 5.5 | 5.4 | 2.5 |
| NPV (`) | 530.50 | 1,591 | 655 |
| IRR (%) | 12.42 | 15.94 | 16.52 |
| ARR (%) | 16 | 26 | 20 | | [
0.03418129310011864,
0.021379586309194565,
0.007115725893527269,
0.004101162776350975,
-0.04723471403121948,
-0.03343635052442551,
-0.0032756568398326635,
0.013257389888167381,
-0.010218233801424503,
0.061798084527254105,
0.03134969621896744,
0.036296941339969635,
0.0188507791608572,
-0.00... |
Inter_P6A_FM_Mod2_Chapter_7_Investment_Decisions.pdf | FM | Study_Material | N/A | [Concept: Theory]
## Comparison of Rankings
| Method | Payback | NPV | IRR | ARR |
|----------|-----------|-------|-------|-------|
| 1 | C | B | C | B |
| 2 | B | C | B | C |
| 3 | A | A | A | A | | [
0.03433869406580925,
0.01889697089791298,
-0.01315989252179861,
0.00546524440869689,
-0.033095523715019226,
-0.03107023984193802,
-0.019597206264734268,
0.010214866138994694,
-0.0061450256034731865,
0.047756846994161606,
0.027234213426709175,
0.03331974521279335,
0.032506514340639114,
-0.0... |
Inter_P6A_FM_Mod2_Chapter_7_Investment_Decisions.pdf | FM | Study_Material | N/A | [Concept: Theory]
## ILLUSTRATION 17
X Limited is considering purchasing of new plant worth ` 80,00,000. The expected net cash flows after taxes and before depreciation are as follows:
| Year | Net Cash Flows ( ` ) |
|--------|------------------------|
| 1 | 14,00,000 |
| 2 | 14,00,000 ... | [
0.022126303985714912,
0.04388495162129402,
0.01770670898258686,
-0.0007855956209823489,
-0.014300234615802765,
-0.04950424283742905,
0.023777222260832787,
0.006721120327711105,
0.007414002437144518,
0.059841614216566086,
0.027742434293031693,
0.02405790239572525,
0.03622205927968025,
0.000... |
Inter_P6A_FM_Mod2_Chapter_7_Investment_Decisions.pdf | FM | Study_Material | N/A | [Concept: Theory]
## (i) Calculation of Pay-back Period
Cash Outlay of the Project =
` 80,00,000
Total Cash Inflow for the first five years =
` 70,00,000
Balance of cash outlay left to be paid back in the 6 th year =
` 10,00,000
Cash inflow for 6 th
year =
` 16,00,000
So, the payback period is between 5 th... | [
0.010011103935539722,
0.0390508659183979,
-0.013391129672527313,
0.0005029350868426263,
-0.019827211275696754,
-0.017659321427345276,
0.013990644365549088,
0.0073026935569942,
0.0010151300812140107,
0.055284809321165085,
0.02225729636847973,
0.009920545853674412,
0.02036592736840248,
-0.02... |
Inter_P6A_FM_Mod2_Chapter_7_Investment_Decisions.pdf | FM | Study_Material | N/A | [Concept: Theory]
## (ii) Calculation of Net Present Value (NPV) @10% discount rate:
| Year | Net Cash Inflow ( ` ) | Present Value at Discount Rate of 10% | Present Value ( ` ) |
|--------|-------------------------|-----------------------------------------|-----------------------|
| | (a) ... | [
0.028345270082354546,
0.04601796343922615,
0.00808702688664198,
-0.0109274722635746,
-0.019939478486776352,
-0.05569911375641823,
0.03374374285340309,
0.02151581645011902,
-0.008717523887753487,
0.045239582657814026,
0.03332000598311424,
0.006575734820216894,
0.04447583109140396,
-0.003985... |
Inter_P6A_FM_Mod2_Chapter_7_Investment_Decisions.pdf | FM | Study_Material | N/A | [Concept: Theory]
## (iv) Calculation of Internal Rate of Return:
Net present value @ 10% interest rate factor has already been calculated in (ii) above, we will calculate Net present value @15% rate factor.
| Year | Net Cash Inflow ( ` ) | Present Value at Discount Rate of 15% | Present Value ( ` ) |
|----... | [
0.032995156943798065,
0.034910380840301514,
-0.0050988090224564075,
-0.03393585979938507,
-0.0326361283659935,
-0.04364349693059921,
0.01920207031071186,
0.008199711330235004,
-0.002231087302789092,
0.06140574812889099,
0.020487479865550995,
0.02753906138241291,
0.008510184474289417,
-0.03... |
Inter_P6A_FM_Mod2_Chapter_7_Investment_Decisions.pdf | FM | Study_Material | N/A | [Concept: Theory]
## ILLUSTRATION 18
HMR Ltd. is considering replacing a manually operated old machine with a fully automatic new machine. The old machine had been fully depreciated for tax purpose but has a book value of ` 2,40,000 on 31 st March . The machine has begun causing problems with breakdowns an... | [
0.02820400707423687,
0.03637758269906044,
-0.0010161143727600574,
0.01767582818865776,
-0.017499499022960663,
-0.02634570375084877,
0.018271472305059433,
0.004450235981494188,
-0.015110264532268047,
0.050683774054050446,
0.03146979957818985,
0.04712976515293121,
-0.0036331694573163986,
0.0... |
Inter_P6A_FM_Mod2_Chapter_7_Investment_Decisions.pdf | FM | Study_Material | N/A | [Concept: Theory]
## PV factors @ 10%:
| Year | 1 | 2 | 3 | 4 | 5 | 6 | 7 | 8 | 9 | 10 |
|--------|-------|-------|-------|-------|-------|-------|-------|-------|-------|-------|
| PVF | 0.909 | 0.826 | 0.751 | 0.683 | 0.621 | 0.564 | 0.513 | 0.467 | 0.424 | 0.386 | | [
0.05714057385921478,
0.03137638047337532,
-0.009050289168953896,
0.028013166040182114,
-0.016751118004322052,
-0.04618260636925697,
0.030361050739884377,
0.016189826652407646,
-0.017664741724729538,
0.03579803183674812,
0.031886953860521317,
0.02423386089503765,
0.043923355638980865,
-0.01... |
Inter_P6A_FM_Mod2_Chapter_7_Investment_Decisions.pdf | FM | Study_Material | N/A | [Concept: Theory]
## 1. Calculation of Base for depreciation or Cost of New Machine
| Particulars | ( ` ) |
|---------------------------------|----------|
| Purchase price of new machine | 4,50,000 |
| Less: Sale price of old machine | 1,00,000 |
| | 3,50,000 | | [
0.016941994428634644,
0.012481026351451874,
0.009773853234946728,
-0.004459771793335676,
-0.005805703345686197,
-0.03851649910211563,
0.027751782909035683,
0.006846372038125992,
-0.010785799473524094,
0.03562218323349953,
0.03026532381772995,
0.01582201197743416,
-0.008374655619263649,
0.0... |
Inter_P6A_FM_Mod2_Chapter_7_Investment_Decisions.pdf | FM | Study_Material | N/A | [Concept: Theory]
## 2. Calculation of Profit before tax as per books
| Particulars | Old machine ( ` ) | New machine ( ` ) | Difference ( ` ) |
|-------------------------------------------|---------------------|---------------------|--------------------|
| PBT as per books ... | [
0.010954737663269043,
0.012385834939777851,
0.0031089531257748604,
-0.008843476884067059,
-0.01207714807242155,
-0.035915836691856384,
0.0013540302170440555,
-0.003647811012342572,
-0.02069399319589138,
0.04889894649386406,
0.013802221976220608,
0.0339268296957016,
0.02999822236597538,
0.0... |
Inter_P6A_FM_Mod2_Chapter_7_Investment_Decisions.pdf | FM | Study_Material | N/A | [Concept: Theory]
## Calculation of Incremental NPV
| Year | PVF @ 10% | PBTD ( ` ) | Dep. @ 7.5% ( ` ) | PBT ( ` ) | Tax @ 30% ( ` ) | Cash Inflows ( ` ) | PV of Cash Inflows ( ` ) |
|--------|-------------|--------------|---------------------|-------------|-------------------|-----------------------... | [
0.03192668408155441,
0.050627466291189194,
-0.012673741206526756,
0.014902044087648392,
-0.009512844495475292,
-0.04146815463900566,
0.005489292088896036,
0.0185878723859787,
-0.005276192910969257,
0.05982377380132675,
0.015920067206025124,
0.0016256151720881462,
0.0488540418446064,
0.0040... |
Inter_P6A_FM_Mod2_Chapter_7_Investment_Decisions.pdf | FM | Study_Material | N/A | [Concept: Theory]
## INVESTMENT DECISIONS
| 8 | 0.467 | 80,000.00 | 15,209.73 | 64,790.27 ... | [
0.03299591690301895,
0.016306662932038307,
-0.008414207957684994,
0.01445072889328003,
-0.050544966012239456,
-0.007957150228321552,
0.026502234861254692,
0.033534131944179535,
-0.006380172912031412,
0.07297727465629578,
0.022867148742079735,
0.027541253715753555,
0.010230215266346931,
0.0... |
Inter_P6A_FM_Mod2_Chapter_7_Investment_Decisions.pdf | FM | Study_Material | N/A | [Concept: Theory]
## SUMMARY
- ♦ Capital budgeting is the process of evaluating and selecting long-term investments that are in line with the goal of investor's wealth maximization.
- ♦ The capital budgeting decisions are important, crucial and critical business decisions due to substantial expenditure in... | [
0.036465130746364594,
0.01567128859460354,
-0.004787340760231018,
0.010015126317739487,
-0.02096674032509327,
-0.017106758430600166,
0.006459478288888931,
-0.018977943807840347,
-0.015299320220947266,
0.06560917943716049,
0.03413693606853485,
0.016996940597891808,
0.010584378615021706,
-0.... |
Inter_P6A_FM_Mod2_Chapter_7_Investment_Decisions.pdf | FM | Study_Material | N/A | [Concept: Theory]
## FINANCIAL MANAGEMENT
- ♦ Payback Period = Total initial capital investment
Annual expected after-tax net cash flow
Payback Reciprocal
=
Average Annual cash in flow
Initial investment
- ♦
- Accounting rate of return (ARR) = Average annual net income Investment
- ♦ Net Present Value Techniq... | [
0.004998454824090004,
0.04291720688343048,
-0.012571261264383793,
-0.03230178356170654,
-0.030319053679704666,
-0.03296495974063873,
0.013183802366256714,
-0.03524449095129967,
-0.004490758758038282,
0.05930789187550545,
0.03017641417682171,
0.030653707683086395,
-0.008094006218016148,
-0.... |
Inter_P6A_FM_Mod2_Chapter_8_Dividend_Decision.pdf | FM | Study_Material | N/A | [Concept: Theory]
## LEARNING OUTCOMES
- ♦ Understand the Meaning of Dividend Decision.
- ♦ Understand the importance of Dividend Decision.
- ♦ Discuss various forms of Dividend.
- ♦ Discuss various Determinants of Dividend.
- ♦ Explain various theories of Dividend Decisions.
<!-- image -->
<!-- image --> | [
0.029862085357308388,
-0.01753412000834942,
-0.022588366642594337,
-0.0257406085729599,
-0.03458256274461746,
-0.039706695824861526,
0.008694982156157494,
0.023145895451307297,
-0.005816570483148098,
0.04624693840742111,
0.0009017330594360828,
0.04870270565152168,
0.05351296067237854,
0.03... |
Inter_P6A_FM_Mod2_Chapter_8_Dividend_Decision.pdf | FM | Study_Material | N/A | [Concept: Theory]
## 1. INTRODUCTION
As we had already discussed in Chapter 1 (Scope and Objectives of Financial Management), Financial Management is the process of making financial decisions so as to increase the value of the firm.
Long term Finance function decisions broadly covers three areas:
- i. Fi... | [
0.02402566932141781,
-0.0030027877073735,
-0.00816341396421194,
-0.010136712342500687,
-0.01048947311937809,
-0.008666595444083214,
0.017095714807510376,
-0.02392324060201645,
-0.012795313261449337,
0.0730687826871872,
0.021390417590737343,
0.028928395360708237,
0.03860710561275482,
-0.000... |
Inter_P6A_FM_Mod2_Chapter_8_Dividend_Decision.pdf | FM | Study_Material | N/A | [Concept: Theory]
## 3. FORMS OF DIVIDEND
Generally, the dividend can be of the following forms (depending upon some factors that will be discussed later):
1. Cash dividend: It is the most common form of dividend . Cash here means cash, cheque, warrant, demand draft, pay order or directly through ... | [
0.00750412791967392,
-0.015785718336701393,
0.006279889028519392,
-0.016777977347373962,
-0.011172288097441196,
-0.013751927763223648,
0.023498140275478363,
0.00008151650399668142,
0.009324807673692703,
0.06445293128490448,
0.02312982827425003,
0.062044404447078705,
0.049539968371391296,
-... |
Inter_P6A_FM_Mod2_Chapter_8_Dividend_Decision.pdf | FM | Study_Material | N/A | [Concept: Theory]
## FINANCIAL MANAGEMENT
Keeping other things same (such as tax considerations etc), the effect of cash dividend and share repurchases on shareholder's wealth is same.
Following example explains the same:
Suppose HM Ltd has 1 cr of equity shares outstanding and proposes to p... | [
0.00683252327144146,
0.02391395904123783,
0.007554776035249233,
-0.034040164202451706,
-0.022458672523498535,
-0.04182584583759308,
0.005201680585741997,
-0.011745885945856571,
-0.026713764294981956,
0.06336264312267303,
0.025398951023817062,
0.044372349977493286,
0.0345517136156559,
0.025... |
Inter_P6A_FM_Mod2_Chapter_8_Dividend_Decision.pdf | FM | Study_Material | N/A | [Concept: Theory]
## Conditions of Stock Dividend or Bonus Issue
To issue Bonus shares, a Company needs to fulfil all the conditions given by Security Exchange Board of India (SEBI). As per SEBI, the bonus shares are issued not in lieu of cash dividends. A bonus issue should be authorised by Article of Association (AO... | [
0.012105874717235565,
0.005113882478326559,
0.019008908420801163,
-0.014082363806664944,
-0.011548095382750034,
-0.005307921674102545,
0.019611753523349762,
0.013243328779935837,
0.0016244436847046018,
0.06058547645807266,
-0.029716573655605316,
0.05828840658068657,
0.029695957899093628,
0... |
Inter_P6A_FM_Mod2_Chapter_8_Dividend_Decision.pdf | FM | Study_Material | N/A | [Concept: Theory]
## (1) To Shareholders:
- (a) No tax is payable by shareholders on stock dividend received from domestic company as it is not treated as dividend but as a capital asset under Income Tax Act, 1961.
- (b) The policy of paying fixed dividend per share and its continuation even after declaratio... | [
-0.0028293791692703962,
0.037157896906137466,
0.02134028449654579,
-0.022633275017142296,
-0.020350096747279167,
-0.0441637858748436,
0.04052074998617172,
0.013518743216991425,
-0.02916327863931656,
0.06665880233049393,
-0.00538209592923522,
0.06362184882164001,
0.025072230026125908,
-0.01... |
Inter_P6A_FM_Mod2_Chapter_8_Dividend_Decision.pdf | FM | Study_Material | N/A | [Concept: Theory]
## Limitations of Stock Dividend
Limitations of stock dividend to shareholders and company are as follows:
1. To Shareholders: Stock dividend does not affect the wealth of shareholders and therefore it has no value for them. This is because the declaration of stock dividend is a method of capitalisi... | [
0.024031100794672966,
0.012473370879888535,
0.01549721509218216,
-0.012291862629354,
-0.007542641833424568,
0.0019913818687200546,
0.013534932397305965,
0.004393509589135647,
-0.02326844446361065,
0.046694546937942505,
0.0002851213503163308,
0.04124399647116661,
0.03436742722988129,
0.0117... |
Inter_P6A_FM_Mod2_Chapter_8_Dividend_Decision.pdf | FM | Study_Material | N/A | [Concept: Theory]
## (i) Long Term Financing Decision:
As we know that one of the financing options is 'Equity'. Equity can either be raised externally through issue of new equity shares or can be generated internally through retained earnings. For Equity, retained earnings are preferable because the... | [
0.026684297248721123,
0.01795952580869198,
-0.0257100872695446,
-0.007336622569710016,
-0.0027555087581276894,
-0.0048266928642988205,
0.01649659126996994,
-0.0015539816813543439,
-0.0038704052567481995,
0.04396258294582367,
0.022848714143037796,
0.028426511213183403,
0.03513452410697937,
... |
Inter_P6A_FM_Mod2_Chapter_8_Dividend_Decision.pdf | FM | Study_Material | N/A | [Concept: Theory]
## DIVIDEND DECISIONS
finance profitable investment opportunities thereby restricting its financing options.
In this backdrop, the decision is based on the following:
1. Whether the organization has opportunities in hand to invest the profit, if retained?
2. Whether the return on such investment (... | [
0.012716012075543404,
-0.023291293531656265,
-0.02205122821033001,
-0.019940968602895737,
-0.02851521223783493,
-0.022486235946416855,
0.015057765878736973,
0.018426373600959778,
-0.03025767020881176,
0.02589385025203228,
0.0030780937522649765,
0.04962148144841194,
0.031299740076065063,
0.... |
Inter_P6A_FM_Mod2_Chapter_8_Dividend_Decision.pdf | FM | Study_Material | N/A | [Concept: Theory]
## (ii) Wealth Maximization Decision:
Under this decision, we are facing the problem as to what amount of dividend shall be distributed i.e. the Dividend Payout ratio (D/P) in relation to Market price of the shares (MPS)? This decision is based on the following:
1. Because of market imperfections... | [
0.021617019549012184,
0.03556676581501961,
0.020762145519256592,
0.01929926685988903,
-0.019203534349799156,
-0.037753526121377945,
0.004853185266256332,
0.0012181221973150969,
-0.018854346126317978,
0.062075477093458176,
-0.00514543941244483,
0.03254109248518944,
0.042116593569517136,
0.0... |
Inter_P6A_FM_Mod2_Chapter_8_Dividend_Decision.pdf | FM | Study_Material | N/A | [Concept: Theory]
## Example - 1
Suppose there are two companies namely A Ltd. & B Ltd. having capital employed of ` 50,00,000 in terms of Equity shares ( ` 100 each are earning @ 20%. Both have same capital structure and same ROI but different dividend policy.
A Ltd. distributes 100% of its earnings whereas B Lt... | [
0.013810265809297562,
0.02398619055747986,
0.015735646709799767,
-0.006440118886530399,
-0.0011839451035484672,
-0.041318733245134354,
-0.0004822076007258147,
-0.0006094275740906596,
-0.01811361126601696,
0.08178453892469406,
0.02880215458571911,
0.047746866941452026,
0.03729221597313881,
... |
Inter_P6A_FM_Mod2_Chapter_8_Dividend_Decision.pdf | FM | Study_Material | N/A | [Concept: Theory]
## 6. DETERMINANTS OF DIVIDEND DECISIONS
The dividend policy is affected by the following factors:
1. Availability of funds: If the business is in requirement of funds, then retained earnings could be a good source. The reason being the saving of floatation cost and prevention of dilution of control... | [
0.00902890507131815,
-0.001780439866706729,
0.011716142296791077,
-0.006152972113341093,
-0.004861833527684212,
-0.021931501105427742,
0.014753224328160286,
-0.0005836112541146576,
-0.030190417543053627,
0.06208840757608414,
0.01529574953019619,
0.012068650685250759,
0.04420292004942894,
-... |
Inter_P6A_FM_Mod2_Chapter_8_Dividend_Decision.pdf | FM | Study_Material | N/A | [Concept: Theory]
## 7. PRACTICAL CONSIDERATIONS IN DIVIDEND POLICY
A discussion on internal financing ultimately turns to practical considerations which determine the dividend policy of a company. The formulation of dividend policy depends upon answers to the following questions:
- Whether there should be a stable p... | [
0.035713620483875275,
0.013274559751152992,
0.00960503052920103,
-0.019979892298579216,
-0.013100686483085155,
-0.007409244775772095,
0.01906687393784523,
-0.004672257229685783,
-0.011674081906676292,
0.049428295344114304,
-0.025069957599043846,
0.06094568595290184,
0.028013290837407112,
0... |
Inter_P6A_FM_Mod2_Chapter_8_Dividend_Decision.pdf | FM | Study_Material | N/A | [Concept: Theory]
## DIVIDEND DECISIONS
of return of a company is greater than return required by shareholders, it would be advantageous for the shareholders to re-invest their earnings.
Risk and financial obligations increase if a company raises capital through issue of new shares where floatation costs are involve... | [
0.0190545953810215,
0.015649886801838875,
0.01808561198413372,
-0.00863400287926197,
-0.018609587103128433,
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-0.010524468496441841,
0.008182027377188206,
-0.021282820031046867,
0.05292985215783119,
0.004917594138532877,
0.05413105711340904,
0.03326789662241936,
0.022172... |
Inter_P6A_FM_Mod2_Chapter_8_Dividend_Decision.pdf | FM | Study_Material | N/A | [Concept: Theory]
## (b) Constraints on Paying Dividends
- (i) Legal : Please see point no. (9) under the heading, 'Determinants of Dividend Decisions'.
- (ii) Liquidity : Payment of dividends means outflow of cash. Ability to pay dividends depends on cash and liquidity position of the firm. A mature company does not ... | [
0.029112379997968674,
0.006073782220482826,
0.001078834175132215,
0.005236739758402109,
0.008652905002236366,
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0.029401510953903198,
0.01509167067706585,
-0.027735376730561256,
0.06890018284320831,
-0.011700991541147232,
0.0418020598590374,
0.03806305304169655,
0.0134... |
Inter_P6A_FM_Mod2_Chapter_8_Dividend_Decision.pdf | FM | Study_Material | N/A | [Concept: Theory]
## FINANCIAL MANAGEMENT
- (iv) Investment Opportunities : If investment opportunities are inadequate, it is better to pay dividends and raise external funds whenever necessary for such opportunities.
- (c) Payout policies: Payout policies can be maintained by fixing the amount or rate of dividend ... | [
0.022857138887047768,
0.0342472642660141,
-0.017180167138576508,
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0.03198070824146271,
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0.05125108361244202,
-0.005035966634750366,
0.02423800528049469,
0.039493948221206665,
0.02... |
Inter_P6A_FM_Mod2_Chapter_8_Dividend_Decision.pdf | FM | Study_Material | N/A | [Concept: Theory]
## DIVIDEND DECISIONS
Contrary to this, Warren Buffet (amongst the richest persons of the world) says:
"We will either pay large dividends or none at all if we can't obtain more money through re-investment (of those funds). There is no logic to regularly paying out 10% or 20% o... | [
0.0034600780345499516,
0.03462345525622368,
0.00957718025892973,
-0.006872161291539669,
-0.021536991000175476,
0.02277618646621704,
0.014084997586905956,
0.013308319263160229,
-0.011734016239643097,
0.037510376423597336,
0.005354704800993204,
0.0035495059564709663,
0.001703272690065205,
0.... |
Inter_P6A_FM_Mod2_Chapter_8_Dividend_Decision.pdf | FM | Study_Material | N/A | [Concept: Theory]
## Lintner's Model
Lintner's model has two parameters:
- i. The target payout ratio,
- ii. The spread at which current dividends adjust to the target.
John Lintner based his model on a series of interviews which he conducted with corporate managers in the mid 1950's. While developing the model, he ... | [
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0.028749721124768257,
0.0117851747199893,
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0.010697683319449425,
0.007189080119132996,
0.02309202216565609,
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0.07262568175792694,
0.031673088669776917,
0.015209072269499302,
0.024180691689252853,
-0.0097... |
Inter_P6A_FM_Mod2_Chapter_8_Dividend_Decision.pdf | FM | Study_Material | N/A | [Concept: Theory]
## MODIGLIANI and MILLER (MM) HYPOTHESIS :
Modigliani - Miller theory was proposed by Franco Modigliani and Merton Miller in 1961. MM approach is in support of the irrelevance of dividends i.e. firm's dividend policy has no effect on either the price of a firm's stock or its cost of capi... | [
0.02464624121785164,
0.012975496239960194,
0.03095688857138157,
-0.025923488661646843,
-0.0031743356958031654,
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0.007151311729103327,
0.005282568279653788,
0.022421466186642647,
0.016921142116189003,
-0.0006817133398726583,
0.02196711115539074,
... |
Inter_P6A_FM_Mod2_Chapter_8_Dividend_Decision.pdf | FM | Study_Material | N/A | [Concept: Theory]
## According to MM Hypothesis
- Market value of equity shares of a firm depends solely on its earning power and is not influenced by the manner in which its earnings are split between dividends and retained earnings.
- Market value of equity shares is not affected by dividend size.
- Unde... | [
0.025958726182579994,
0.02028328739106655,
0.012282605282962322,
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0.07662780582904816,
0.017404405400156975,
0.06147320568561554,
0.021369535475969315,
-0... |
Inter_P6A_FM_Mod2_Chapter_8_Dividend_Decision.pdf | FM | Study_Material | N/A | [Concept: Theory]
## Assumptions of MM Hypothesis
MM hypothesis is based on the following assumptions:
- Perfect capital markets: The firm operates in a market in which all investors are rational and information is freely available to all.
- No taxes: There are no taxes or no tax discrimination between dividend incom... | [
0.016339994966983795,
0.02627653069794178,
0.016437921673059464,
-0.021103957667946815,
-0.0017141385469585657,
0.02114875800907612,
-0.005015720147639513,
0.013954474590718746,
-0.03816913068294525,
0.07215701788663864,
0.046082109212875366,
0.012497327290475368,
-0.019034255295991898,
-0... |
Inter_P6A_FM_Mod2_Chapter_8_Dividend_Decision.pdf | FM | Study_Material | N/A | [Concept: Theory]
## Situations under MM Hypothesis
Keeping in mind assumptions under MM Hypothesis, firms may have three possible situations regarding the payment of dividend as follows:
1. Firm pays cash dividends from Reserve & Surplus: In this situation, the shareholders receive cash (dividend) from the fi... | [
0.024257224053144455,
0.017753662541508675,
0.00892654899507761,
-0.012345556169748306,
-0.025921160355210304,
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0.005278150085359812,
0.018116630613803864,
-0.030654991045594215,
0.07072547823190689,
0.029687726870179176,
0.04053758829832077,
0.03108103573322296,
-0.01... |
Inter_P6A_FM_Mod2_Chapter_8_Dividend_Decision.pdf | FM | Study_Material | N/A | [Concept: Theory]
## Example - 2:
At the end of the current Financial Year, Dev Ltd. has 2 lakhs outstanding equity shares with market price of ` 10 per share with no other external borrowings since the company follows no borrowing policy. The company has used all its retained earnings for capital expenditure. The com... | [
0.01481141708791256,
0.024377763271331787,
0.00428032549098134,
-0.012916124425828457,
0.014571361243724823,
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0.022689159959554672,
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0.0863555520772934,
0.035348325967788696,
0.04089285805821419,
0.0407867394387722,
-0.00680... |
Inter_P6A_FM_Mod2_Chapter_8_Dividend_Decision.pdf | FM | Study_Material | N/A | [Concept: Theory]
## DIVIDEND DECISIONS
- (ii) As the company strictly follows the no borrowing policy, then to pay the dividend of ` 3 per share, it will have to issue new shares to finance the dividend payment as no retained earnings is available.
$$Market price per share (P1) = Po (1+ K e)... | [
0.03677484393119812,
0.03491455316543579,
0.023909665644168854,
-0.018928026780486107,
-0.014859812334179878,
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0.04700513929128647,
0.01343062985688448,
-0.01585058681666851,
0.05850350484251976,
0.001210319111123681,
0.046254221349954605,
0.053501274436712265,
0.03294... |
Inter_P6A_FM_Mod2_Chapter_8_Dividend_Decision.pdf | FM | Study_Material | N/A | [Concept: Theory]
## Thus, it can be seen from the above example that the value of the firm remains the same in either case.
MM hypothesis is primarily based on the arbitrage argument. Through the arbitrage process, MM hypothesis discusses how the value of the firm remains same whether the firm pays divi... | [
0.03181944042444229,
0.03626181557774544,
0.002695632865652442,
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-0.0005495828227140009,
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-0.015551288612186909,
0.05261937901377678,
0.05704560503363609,
0.04255859553813934,
0.012477011419832706,
-0... |
Inter_P6A_FM_Mod2_Chapter_8_Dividend_Decision.pdf | FM | Study_Material | N/A | [Concept: Theory]
## FINANCIAL MANAGEMENT
∆n
= Number of shares issued to raise the funds required
I
= Amount required for investment
E
= Total earnings during the period
For Understanding purpose:
<!-- formula-not-decoded -->
The above equation is for one share. Let's multiply it with n i.e. existing number o... | [
0.027407191693782806,
0.01868097484111786,
0.0032309810630977154,
0.00003837528493022546,
-0.00018757030193228275,
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0.036303456872701645,
-0.018590806052088737,
-0.00797588936984539,
0.07511632144451141,
0.039073396474123,
0.029974935576319695,
0.01443121861666441,
-0... |
Inter_P6A_FM_Mod2_Chapter_8_Dividend_Decision.pdf | FM | Study_Material | N/A | [Concept: Theory]
## ILLUSTRATION 1
AB Engineering Ltd. belongs to a risk class for which the capitalization rate is 10%. It currently has outstanding 10,000 shares selling at ` 100 each. The firm is contemplating the declaration of a dividend of ` 5 share at the end of the current financial year. It expects... | [
0.01674272119998932,
0.04361198842525482,
-0.003707824507728219,
-0.032005418092012405,
0.018148386850953102,
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0.02454470656812191,
-0.002092302544042468,
-0.008618898689746857,
0.04959060996770859,
0.03650277107954025,
0.023049786686897278,
0.058414798229932785,
0.005... |
Inter_P6A_FM_Mod2_Chapter_8_Dividend_Decision.pdf | FM | Study_Material | N/A | [Concept: Theory]
## CASE 1: Value of the firm when dividends are not paid.
Step 1: Calculate price at the end of the period
<!-- formula-not-decoded -->
<!-- formula-not-decoded -->
Step 2: Calculation of funds required for investment
| Earning | ` 1,00,000 |
|-----... | [
0.013883223757147789,
0.031016353517770767,
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0.002396473428234458,
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0.026879098266363144,
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0.06679666042327881,
0.03369610011577606,
0.0410631038248539,
0.03677807375788689,
-0.00... |
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