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Capital Budgeting Processes and Techniques, NPV, IRR, Regina Velázquez,…
Capital Budgeting Processes and Techniques
NPV (Net Present Value)
Calculates present value of cash flows
Uses discount rate to reflect risk
Positive NPV indicates investment is profitable
Generally preferred for ranking projects
NPV is often the preferred method due to its direct measure of profitability and ability to handle complex scenarios
IRR (Internal Rate of Return)
Calculates discount rate where NPV equals zero
Compares IRR to hurdle rate
Higher IRR than hurdle rate suggests investment
Understanding the limitations of IRR is crucial for accurate
Problems with IRR
Unusual Cash Flows
Borrowing vs. lending problem
Multiple IRRs
Scale Problem: May not accurately rank projects of different size
Cash Flows and Capital Budgeting
It covers the necessary capital equipment, operating costs, revenue streams, and net present value analysis
LASIK surgery can be a profitable investment for ophthalmologists
is important to consider the factors that can influence its financial success
competition and pricing
Medical and operational aspects
Constantly evolving technology:
Financial and investment aspects
High initial cost
Equipment depreciation
Variable operating costs
Importance of patient attraction
Net present value (NPV) analysis
Similarities NPV and IRR: Adjust for risk and timing of cash flows and use discount rate for comparison. valuable tools for investment evaluation
Diferences
Cost of Capital and Project Risk
We have to indentify base line assuptions (initial NPV and patiens per year)
Then the sensitive to patient volume
Impact of price: The price cut to $2,700: NPV falls by 42% and break-even price: $2294
Discount rate effect: 15% discount rate: NPV= $1.5 M and Project viable below a 91% discount rate
We have to make a sensitivity analysis to test the effect of changing one variable. we have 2 different escenarios
Pessimistic Scenario: 750 patients, $2,500 price: NPV = -$364K Adjustments lead to small positive NPV: $1,118
Optimistic Scenario:1,200 patients, $3,500 price: NPV = $3.8M
NPV
Directly measures profitability in dollars
Less sensitive to scale problems
IRR
Measures percentage return
Can be difficult to interpret with unusual cash flows
Can conflict with NPV rankings
Regina Velázquez, Mariela Miron, Cintya Salazar