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Learning Objectives
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10.1
Comparing Mutually Exclusive
Alternatives By Different Evaluation
Methods
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In chapters 5, 6, 7, 8, and 9:
The basic cash flow evaluation methods
have been shown.
Present Worth,
Annual Worth,
Future Worth,
Rate of Return, and
Benefit/Cost.
Any of the above methods, correctly
used, will result in the same outcome.
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Private Sector:
Some cost-only types (Service-type);
Assume any revenue cash flows are
identical for all identified alternatives.
Mixture of costs and revenues.
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Manual methods
Computer (spreadsheet models) or
specialized software specific to the
industry or sector.
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10.2
MARR Relative to the Cost of Capital
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issuing) company.
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The 8% floor is
then modified
upward by adding
additional %
increments until a
11% MARR rate is
reached.
Note the
additional
increments added
in!
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MARRafter tax
MARRBeforeTax
1 - Tax Rate
Some firms establish the MARR (after-tax) and then compute the
before-tax MARR to apply to economic studies where tax implications
are ignored.
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10.3
Debt-Equity Mix and Weighted
Average Cost of Capital
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WACC = 10.88%
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10.3 WACCs…
Can be computed two ways:
Using a before-tax cost of capital, or
After-tax cost of capital.
An after-tax calculation is preferred:
After-tax includes the tax deductibility of the
interest on debt capital.
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10.4
Determination of the Cost
of Debt Capital
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=E7
=E11*(1-$B$7)
=IRR(E4:E14) =IRR(F4:F14)
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10.5
Determination of the Cost of Equity
Capital and the MARR
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10.5 Stock
Stock represents “ownership.”
Individuals generally buy stock in a
company in anticipation of the
appreciation of the price of the stock over
time.
Stock generally pays periodic dividends to
the current stock holder.
Dividends come from after-tax profits.
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10.5 Example:
What is cost, using the Dividend Growth
Model, for this situation?
Calculate Re as:
Re = 1/20 + 0.04 = 0.09 = 9%
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10.5 CAPM
CAPM has two components:
1. A risk-free return,
2. A premium above the risk-free
return.
The Re using the CAPM model is:
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Re = Rf + (Rm –Rf)
10.5 CAPM – Elements
Re = estimated cost of common stock using
the CAPM model.
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Re = Rf + (Rm –Rf)
10.5 The Coefficient
The coefficient is a multiplier.
values range from 0 upward.
< 1 indicates less volatility:
Less of a premium for risk.
> 1:
Expect large price movements;
Hence a greater risk premium is added.
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10.5 Implications
High values – higher risk premiums are
required.
A risk-free investment:
U.S. Treasury Bills…
Will have values very low, or = 0.
values are periodically published for
most publicly-held corporations.
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10.6
Effect of Debt-Equity Mix on
Investment Risk
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10.7
Multiple Attribute Analysis:
Identification and Importance of
Each Attribute
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5. Evaluate each
5. Evaluate each alternative using a alternative:
Multiple-attribute technique. Use sensitivity
Use sensitivity analysis for key analysis.
attributes.
6. Select, then
7. Execute.
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10.7 UA Approach . . .
UA is faced with:
Quantative parameters, and
Noneconomic attributes.
UA conducts a Delphi study;
From 25 key UA personnel,
Along with data from recent purchases from
Boeing.
They defined 10 key attributes for options
selection.
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10.7 UA Approach . . .
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1 W1
2 W2
3 W3 Value ratings
. . Vij
. .
m Wm
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W
i 1
i 1.00
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importance score
i=1
i
importance scorei
[10.9]
S
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1. Equal Weighting.
All attributes are assumed to carry equal
weight (not often realistic!).
2. Rank Order.
The m attributes are first ranked in order of
perceived importance.
3. Weighted Rank Order
Place the m attributes in order of importance,
but differentiation between attributes is now
possible.
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Popular Approach!
The defined attributes are ranked by the
analyst in order of increasing importance.
A score of “1” is assigned to the least
important attribute:
“m” is assigned to the perceived most
important attribute.
Weights:
1/m, 2/m, . . . , m/m. {Consistent weighting}
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si 1
i This is perhaps
the best overall
method and
permits maximum
flexibility.
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Subjective score
between [ 0 – 10 ]
assigned! For A1
Computed
rank scores
for each
Alternative.
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Subjectively
assigned!
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Attribute Weights
Alternative 1
Safety 0.500 6
Repair Time 0.250 9
Crew Needs 0.125 5
Economic 0.125 5
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10.8
Evaluation Measure for Multiple
Attributes
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R j WV
i ij
j 1
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3 Alternatives;
6 attributes – scores shown below.
Attriibute Importance
i Score
1 50
2 100
3 100
4 80
5 50
6 70
450
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10.8 MA Approach
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Chapter Summary
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10. Summary
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10. Summary
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10. Summary
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10. Summary
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10. Summary
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10. Summary
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10. Summary
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