Azure Lodging, Inc.: A Case Study on Capital Budgeting with Capital Rationing in a Service Industry Context

2021 ◽  
Author(s):  
Michael Burkert ◽  
Thomas Calderon ◽  
James W Hesford ◽  
Michael James Turner
Keyword(s):  
Net Present Value ◽  
Service Industry ◽  
Capital Budgeting ◽  
Monte Carlo Analysis ◽  
Cash Flows ◽  
Managerial Accounting ◽  
Advanced Technique ◽  
Capital Rationing ◽  
Future Cash Flows

This case illustrates capital budgeting in a service industry context. Three features should make this case attractive to instructors. First, the firm's rationing of capital means that students must select one investment among competing investment alternatives. Second, the project involves renovation of an existing hotel. Most cases consider a business expansion where analysis involves estimation of a single series of cash flows to generate net present value (i.e., future cash flows or not). In this case, students model cash flows if the project is accepted, comparing those cash flows to a model of cash flows if the hotel continues without renovation. Third, we introduce Monte Carlo analysis, an advanced technique for assessing uncertainty. The extensive data students use in this case is from an actual hotel chain's project database. The case has been used in undergraduate and graduate managerial accounting classes.

scholarly journals Reinvestment Bias When Analyzing Mutually Exclusive Assets

2011 ◽  
Vol 2 (3) ◽  
pp. 71
Author(s):  
Robert J. Sweeney
Keyword(s):  
Net Present Value ◽  
Capital Budgeting ◽  
Cash Flows ◽  
Rate Of Return ◽  
Internal Rate Of Return ◽  
Present Value ◽  
Internal Rate ◽  
Current Period ◽  
The Cost ◽  
Flows Over Time

Capital budgeting decisions generally involve the commitment of resources in the current period to secure positive cash flows over time that generate a rate of return in excess of the cost of the funds invested. The most common techniques used to perform this analysis are the Net Present Value (NPV) and the Internal Rate of Return (IRR).Conceptually, these two techniques are substitutable; i.e. the resulting decision from a NPV analysis is identical to the decision from an IRR analysis. In practice, however, the NPV and the IRR can, on occasion, produce conflicting decisions. Specifically, when analyzing mutually exclusive assets the Net Present Value can support one asset while the Internal Rate of Return supports the other. The purpose of this paper is twofold; first, to highlight structural deficiencies in the conventional application of the NPV and the IRR, and second, to demonstrate a procedure to correct for these structural errors.

scholarly journals Use of Probabilistic Cash Flows in Analyzing Investments Under Conditions of Risk and Uncertainty

1976 ◽  
Vol 8 (2) ◽  
pp. 19-24 ◽  
Author(s):  
James W. Richardson ◽  
Harry P. Mapp
Keyword(s):  
Net Present Value ◽  
Average Rate ◽  
Capital Budgeting ◽  
Cash Flows ◽  
Rate Of Return ◽  
Internal Rate Of Return ◽  
Risk And Uncertainty ◽  
Small Farm ◽  
Perfect Knowledge ◽  
Net Returns

Managers of business firms, large or small, farm or nonfarm, must make investment decisions under conditions of risk and uncertainty. However, in evaluating investments, the assumption of perfect knowledge has often been used to simplify the analysis. For example, an estimate of average annual net returns is frequently discounted into perpetuity to evaluate a real estate investment alternative. Capital budgeting literature suggests a number of approaches to evaluating alternative investments. However, use of concepts such as the payback period, average rate of return, internal rate of return and net present value embodies the assumption of perfect knowledge.

Capital Budgeting: Maledia Broadcasting Ltd

2020 ◽  
Vol 17 (2) ◽  
pp. 241-256
Author(s):  
Keyoor Purani ◽  
Krishnan Jeesha
Keyword(s):  
Net Present Value ◽  
Real Life ◽  
Capital Budgeting ◽  
Cash Flows ◽  
New Venture ◽  
Project Finance ◽  
Corporate Context ◽  
Real Life Situation ◽  
The Media ◽  
The Rich

In 2011, Samjad, deputy CEO of Maledia Broadcasting Limited (MBL)—a new venture of the media group Maledia, based in Cochin, India—prepared to make financial projections to justify the feasibility of the new Malayalam news channel. He was faced with challenges of making estimates that made the project attractive yet practical and credible for the group that was conservative in their advertising sales approach. Set in an interesting industry like broadcasting, the case simulates a real-life situation that also provides a internal corporate context. With the help of the rich market data such as advertising spends, commercial time, competitive scenario in the region, students are expected to forecast revenue for the project. Students are also challenged to use benchmark data of competitors to estimate hurdle rate, capex and operating costs. Estimation of initial investments is also required to be made. Using the processed financial data and projections, students are required to prepare discounted cash flows (DCF) statements with net present value (NPV) and internal rate of return (IRR) for the broadcast channel project. They learn to build alternate scenarios to deal with decisions under uncertainty. The case provides several opportunities to discuss narratives and numbers, helping students of finance realize the value of analysing the company policies and values, business situation, market environment and competitive financial information in capital budgeting, and project finance beyond number crunching.

scholarly journals Application of Capital Budgeting Method to Evaluate Investment Decisions on Additions to Fixed Assets at PT Hatten Bali

2021 ◽  
Vol 4 (1) ◽  
pp. 69-76
Author(s):  
Ni Luh Gede Wahyu Pradnyawati ◽  
◽  
I M A Putrayasa ◽  
I G A O Sudiadnyani ◽  
◽  
...  
Keyword(s):  
Net Present Value ◽  
Average Rate ◽  
Investment Decision ◽  
Investment Decisions ◽  
Capital Budgeting ◽  
Rate Of Return ◽  
Study Approach ◽  
Fixed Assets ◽  
Research Analysis

This research was conducted to evaluate the investment decision to add fixed assets by PT Hatten Bali using the capital budgeting method. The results of this study are expected to be used as material for evaluating the application of the capital budgeting method in making investment decisions on fixed assets at PT Hatten Bali. The data used for this study were obtained from interviews and documentation and were analyzed using descriptive qualitative research analysis techniques with a case study approach. Based on the results of research using the capital budgeting method which consists of the method of calculating the payback period, net present value, profitability index, internal rate of return and average rate of return, all of which have shown a favorable results. From these results it can be concluded that the investment decision to add fixed assets in the form of distribution vehicles made by PT Hatten Bali can benefit the company in stable sales conditions and the application of capital budgeting methods can reduce the risk of errors or failures in making investment decisions and improve subsequent investment decisions.

Purchasing power return, a new paradigm of capital investment appraisal

2018 ◽  
Vol 44 (2) ◽  
pp. 241-256 ◽  
Author(s):  
David DeBoeuf ◽  
Hongbok Lee ◽  
Don Johnson ◽  
Maksim Masharuev
Keyword(s):  
Capital Investment ◽  
Net Present Value ◽  
Capital Budgeting ◽  
Cash Flows ◽  
Purchasing Power ◽  
New Paradigm ◽  
Content Type ◽  
Investment Projects ◽  
Investment Appraisal ◽  
The Many

Purpose The purpose of this paper is to contribute to financial managers’ capital budgeting decision-making processes by proposing a new paradigm of capital investment appraisal. The expected return, required return structure of the proposed purchasing power return (PPR) methodology eliminates the many flaws associated with the competing internal rate of return (IRR) and modified IRR (MIRR) techniques. Design/methodology/approach The authors provide a new framework for examining long-term investment projects through a percentage return prism. Unlike that of IRR and MIRR, mathematical consistency with net present value (NPV) is a design requirement. Findings PPR eliminates the many flaws found in the IRR and MIRR methodologies, is mathematically consistent with NPV, and identifies positive-NPV investments forecasted to reduce the company’s purchasing power. These projects are acceptable under NPV, but flagged for additional review and potential rejection. Created to examine projects on a percentage return basis, PPR employs market-based inflation rates to convert all cash flows into constant purchasing power units of measure. From these units, an expected real return is estimated and compared to the project’s inflation-adjusted required return, resulting in an accept/reject decision consistent with that of NPV. Originality/value The proposed PPR is a new paradigm of capital investment appraisal that eliminates the many problems found in the IRR and MIRR techniques, is mathematically consistent with the NPV method, and helps financial decision makers examine investment projects on an expected percentage return basis. PPR also flags for further review projects expected to actually reduce the company’s purchasing power.

scholarly journals The Extent of Using and Trusting Capital Budgeting Methods in Projects Appraisal in Palestinian Corporations

2018 ◽  
Vol 12 (6) ◽  
pp. 151
Author(s):  
Ahmad N. H. Anabtawi
Keyword(s):  
Net Present Value ◽  
Capital Budgeting ◽  
Cash Flows ◽  
Payback Period ◽  
The Other ◽  
Present Value ◽  
Internal Rate ◽  
Public Corporations ◽  
Rate Of Returns ◽  
Accounting Rate

This research paper aims to find the degree of the use as well as the trust of the Net Present Value (NPV), Payback Period (PBP), Internal Rate of Returns (IRR) and Accounting Rate of Returns (ARR) as a key capital budgeting method. The research conducted on the listed corporations in Palestine which are 48 company. A questionnaire distributed on 77 financial and project/operations managers in these corporations with 67 responds. The result shows that both discounted and non-discounted cash flows methods are used and trusted by Palestine public corporations. However, on the other hand, the above four methods are volatile in term of use and trust. The most used and trusted capital budgeting method is the Payback period (PBP). This followed by the Net Present Value (NPV). Accounting Rate of Retunes (ARR) becomes third. Thus the least used and trusted method is the Internal Rate of Returns (IRR). 

A New Approach to Capital Budgeting in Closely-Held Firms and Small Firms

1981 ◽  
Vol 5 (4) ◽  
pp. 30-35 ◽  
Author(s):  
Thomas H. McInish ◽  
Ronald J. Kudla
Keyword(s):  
Small Firms ◽  
Net Present Value ◽  
Cost Of Capital ◽  
Weighted Average ◽  
Capital Budgeting ◽  
Cash Flows ◽  
Separation Principle ◽  
Discount Rates ◽  
Present Value ◽  
Investor Returns

The traditional application of the net present value method in capital budgeting involves the use of market derived discount rates such as the cost of capital. Justification of these discount rates stems from the separation principle that states that investment decisions can be made independent of shareholders' tastes and preferences. The purpose of this paper is to show that the separation principle does not hold for closely-held firms and small firms, and, accordingly, market-derived discount rates are inappropriate. Two capital budgeting techniques which are appropriate for these firms are presented. Accept/reject decisions for capital budgeting projects are often made using a technique known as “net present value” (NPV).1 Using the NPV method, acceptable projects are those for which the project's cost is less than the present value of the project's cash flows discounted at the firm's cost of capital; in other words, acceptable projects have a positive NPV. The firm's cost of capital is usually taken to be the weighted average of the firm's cost of equity and debt as measured by investor returns in the capital markets. Justification for use of a discount rate, determined by reference to market-wide investor returns, is based on “the separation principle” which asserts that corporations can make capital budgeting decisions independently of their shareholders' views.2 But because a critical assumption of the separation principle is that shares are readily marketable, it is likely that the separation principle and, hence, market-determined discount rates are inappropriate for closely-held firms and small firms.3 In this paper, we discuss two capital budgeting approaches which are applicable to firms whose shares are not readily marketable. This paper is divided into five sections. First, we discuss the traditional net present value approach to capital budgeting and, then, we indicate in detail, why it may not be suitable for use by closely-held firms and small firms. In the third and fourth sections, we explain two capital budgeting techniques which may be appropriate for use by these firms. Finally, we summarize our conclusions.

scholarly journals APPRAISAL OF COMBINED AGREEMENTS IN BOT PROJECT FINANCE: FOCUSED ON MINIMUM REVENUE GUARANTEE AND REVENUE CAP AGREEMENTS

2010 ◽  
Vol 14 (2) ◽  
pp. 139-155 ◽  
Author(s):  
Jaebum Jun
Keyword(s):  
Option Pricing ◽  
Net Present Value ◽  
Capital Budgeting ◽  
Radical Change ◽  
Cash Flows ◽  
Project Finance ◽  
Value Analysis ◽  
The Government ◽  
Option Pricing Theory ◽  
Bot Project

Limited public funds for infrastructures have the government consider joining the private in a BOT project finance scheme. Generally, the BOT projects entail lots of managerial flexibilities that may induce the radical change of project's cash flows, an asymmetric payoff, when facing on the uncertainties due to the BOT project finance's unique characteristics. Among various managerial flexibilities in the BOT projects, the MRG (Minimum Revenue Guarantee) and the RCP (Revenue Cap) agreements are frequently used to protect the government and the developer from the operational risk. However, the combined effect of the MRG and RCP on the project value is not understood well because the traditional capital budgeting theory, the NPV (Net Present Value) analysis, is limited to assess the contingency of these agreements. So, the purpose of this paper is to develop the numerical model to assess the combined impact of the MRG and RCP agreements on the project value based on the option pricing theory and to suggest a theoretical framework. The approach applied in this paper is justified with the hypothetical BOT toll case and some meaningful conclusions are drawn from. The results by the option pricing concept are analyzed over those by NPV analysis and, finally, the combined value of the MRG and RCP agreements appears significant relative to the project value. Santruka Del ribotu viešojo sektoriaus lešu vyriausybe nusprende sujungti privačias lešas pagal SVP (angl. BOT) projektu finansavimo schema. Paprastai SVP projektai yra lanksčiai valdomi, todel gali sukelti radikaliu pokyčiu grynuosiuose projekto pinigu srautuose asimetrini atsipirkima del unikaliu SVP projektu finansavimo savybiu. Tarp ivairiu lanksčiu SVP projektu valdymo pavyzdžiu minetini minimalios pajamu garantijos (angl. MRG) ir pajamu kapitalizacijos (angl. RCP) susitarimai. Jie dažnai naudojami siekiant apsaugoti valdžia ir vystytoja nuo veiklos rizikos. Tačiau bendras minimaliu pajamu garantiju ir pajamu kapitalizacijos susitarimu poveikis projekto vertei nesuprantamas ir del to, kad tradicine kapitalo teorija, grynosios dabartines vertes (angl. NPV) analize yra ribotos vertinant nenumatytus šiu susitarimu atvejus. Taigi šio straipsnio tikslas ‐ pletoti skaitmenini modeli, ivertinti bendra minetu susitarimu poveiki projekto vertei, pagristai pasirinkto sandorio ikainojimo teorija, ir pasiūlyti teorini pagrindima. Šiame straipsnyje taikomas metodas pagristas hipotetiniais SVP rinkliavos atvejais ir kai kuriomis padarytomis išvadomis. Pasirinkto sandorio ikainojimo samprata analizuojama atliekant grynosios dabartines vertes analize, kol bendra minimaliu pajamu garantiju ir pajamu kapitalizacijos susitarimu verte tampa labai svarbi, palyginti su projekto verte.

scholarly journals The Financial Valuation Risk in Pepper Production: The Use of Decoupled Net Present Value

Mathematics ◽  
2020 ◽  
Vol 9 (1) ◽  
pp. 13
Author(s):  
Josefa López-Marín ◽  
Amparo Gálvez ◽  
Francisco M. del Amor ◽  
Jose M. Brotons
Keyword(s):  
Interest Rates ◽  
Risk Evaluation ◽  
Net Present Value ◽  
Cash Flows ◽  
Present Value ◽  
Financial Valuation ◽  
Production Activity ◽  
Quality Water ◽  
Future Cash Flows ◽  
Over Time

Greenhouse peppers are one of the most important crops globally. However, as in any production activity, especially agricultural, they are subject to important risk factors such as price fluctuations, pests, or the use of bad quality water. This article aims to evaluate the viability of these types of crops by using discounted cash flows. Risk evaluation has been carried out through the analysis of pepper plantations for 2016 and 2017. The traditional application of this tool has significant limitations, such as the discount rate to be used or the estimation of future cash flows. However, by using discount functions that decrease over time in combination with decoupled net present value, these limitations are expected to improve. The use of decoupled net present value has permitted an increase in the accuracy and quantification of risks, isolating the main risks such as price drops (EUR 3720 ha−1 year−1) and structural risks (EUR 1622 € ha−1 year−1). The use of decreasing discount functions has permitted a more realistic investment estimation. Finally, the sensitivity analysis shows that decoupled net present value (DNPV) is little affected by changes in interest rates in contrast to traditional net present value (NPV).

scholarly journals SEQUENTIAL CAPITAL INVESTMENT DECISION MAKING UNDER EXTREME CASH FL OW SITUATIONS: EVIDENCE USING MONTE CARLO SIMULATION

2015 ◽  
Vol 16 (5) ◽  
pp. 877-900 ◽  
Author(s):  
Wenqing Zhang ◽  
Prasad Padmanabhan ◽  
Chia-Hsing Huang
Keyword(s):  
Monte Carlo Simulation ◽  
Monte Carlo ◽  
Capital Investment ◽  
Net Present Value ◽  
Capital Budgeting ◽  
Cash Flows ◽  
Present Value ◽  
Short Term ◽  
Value Analysis

Uncertainty influences a decision maker's choices when making sequential capital investment decisions. With the possibility of extremely negative cash inflows, firms may need to curtail operations significantly. Traditional Net Present Value analysis does not allow for efficient management of these problems. In addition, firm managers may behave irrationally by accepting negative Net Present Value projects in the short term. This paper presents a Monte Carlo simulation based model to provide policy insights on how to incorporate extreme cash flows and manager irrationality scenarios into the capital budgeting process. This paper presents evidence that firms with irrational managers and experiencing extremely negative cash flows may, under certain conditions, reap long term rewards associated with the acceptance of negative Net Present Value projects in the short term. These benefits are largest if cost ratios (discount rates) are small, or investment horizons are high. We argue that acceptance of short term negative Net Present Value projects implies the purchase of a long term real option which can generate positive long term cash flows under certain conditions.

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