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Financial Management

The Pro Readers > Financial Management

Foreign Exchange Rate

    Foreign Exchange Rate Foreign exchange rate is the price at which currency of one country is exchanged with currency of another currency. There are two methods of presenting currencies; Direct Quote Indirect Quote 1) Direct Quote Direct quote is the number of units required for domestic currency to be exchanged with foreign currency. In the direct quote domestic currency is written first. For example, Pakistan rupees with US dollar can be expressed in direct quote as Rs.160 for US $ 1. This is written as Rs.160 / $1. 2) Indirect Quote Indirect quote is the number of units required for foreign currency to be exchange with local currency.In...

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Modified Internal Rate of Return (MIRR)

    How MIRR is different from IRR Modified internal rate of return is a calculation of the return from a project, with an assumption that cash flows earned from a project shall be reinvested to earn a return equal to the company’s cost of capital (Ke) and not IRR. Therefore, in the example of the project with an NPV of Rs.500,000 at a cost of capital (Ke) of 10%, MIRR would be calculated with the assumption that project cash flows are reinvested at a return of 10% per year (which is company cost of capital ke) and not at 15% which is...

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Internal Rate of Return (IRR)

  Internal Rate of Return (IRR) The internal rate of return (IRR) is another method investment appraisal other than Net Present Value (NPV). It is the discount rate which makes Net Present Value Zero. The companies have their own target of rate of return on particular projects. If internal rate of return (IRR) is higher or equal to the project rate of return ascertained by the company then project is feasible and should be accepted. If internal rate of return (IRR)is lower than the project rate of return ascertained by the company then the project needs to be rejected.   How to calculate Internal rate...

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Time value of money

    Introduction Time value of money is the basic concept of finance which says that value of money as of today is more than value of money in the future period. To calculate time value of money we have two methods; Compounding Discounting       Time value of money - Compounding Compounding is the estimate of future cash flows that shall arise when any sum of amount is invested at a given interest rate for a given time period. An amount that is invested today is multiplied by compound factor to arrive at future cash flows at specific interest rate. Where: i = interest rate n = number of years   Example 1: A company wants...

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Bailout Payback Period

Bailout payback period

          Introduction  The bailout payback period considers the time period within which cumulative cash flows are generated by the project after adding cashflows generation from the sale of equipment. Bailout cash flows are the estimates of cash flows inflows that shall arise on sale of equipment at the end of the project or cash out flows that shall be the estimated cost required at the time closure of project. The cash inflows from the sale of equipment reduces / falls every year. Hence, the disposal amount received in year 4 for example shall be lower than amount received in year 3. Decision Rule: A maximum payback...

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Accounting Rate Of Return (ARR)

    Accounting Rate of Return (ARR)   Accounting rate of return (ARR) is the return on investment based on specific project. It is calculated by dividing accounting profit after depreciation but before interest and tax (PBIT) with average capital invested.   Formula of ARR   Average Capital Employed   Average capital employed is calculated by taking average of cost of asset and residual value of asset and then working capital is added.   Formula of Average Capital Employed   Example:  A company is considering a project which requires investment on the machinery amounted to Rs.150,000. The machinery life is four years having scrap value of Rs.30,000. Additional capital requirement for the project is Rs.20,000. The...

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WACC (Weighted Average Cost of Capital)

[vc_row triangle_shape="no"][vc_column][vc_column_text]   Introduction Weighted Average Cost of Capital (WACC) is the cost of debt and cost of equity from company perspective. The required rate of return is from the investors’ perspective which is the return required to benefit the investor for the perceived level of risk. The cost of capital is from the company perspective, which is the minimum return the company must produce to benefit investors. Inequality of investor rate of return and company cost of capital Both investor required rate of return and company cost of capital are not equal because company received tax relief on the interest, e.g. for investment in debenture...

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Payback Period

Bailout payback period

    What is payback period The Payback Period defines the length of time before which the amount invested in the project shall be recovered / received. It is measured in period / time. It is based on cash flows and not on profit. Decision Rule: If expected payback period from the project is within the period determined by the company, the project is accepted and vice versa. For more than one projects, the quickest payback period achieving project is selected.   [mkd_blockquote text="Time value of money is ignored in payback period and total return on the investment is also not considered." title_tag="h2" width="" border_color=""]     Payback Period with even...

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Discounted Payback Period

The discounted payback period is calculated by the same way as payback period the only difference is that cash flows are converted into present value. It is the period before which the Present Value of cumulative cash flow becomes zero. Example: Discounted Payback period with even annual cash flow (constant cashflow) A company is considering a project with initial investment of Rs.700,000. The constant cash flows to be received from the project is Rs.200,000 for a period of 6 years. Discount Rate is 13%. Answer:               The discounted payback period shall be calculated as follows: Year Cash Flow (Rs) Discount Factor (13%) PV of Cash Flow (Rs) Cumulative PV (Rs) 0 (700,000) 1 (700,000) (700,000) 1 200,000 0.884 176,800 (523,200) 2 200,000 0.783 156,600 (366,600) 3 200,000 0.693 138,600 (228,000) 4 200,000 0.613 122,600 (105,400) 5 200,000 0.542 108,400 3,000 6 200,000 0.480 96,000 99,000 NPV     99,000     The...

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