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Unit 5 Capital Budgetting - Coggle Diagram

- - - - The one with higher ROI
- - - - $$\text{ROI} = \left( \frac{\text{Annual Earnings}}{\text{Total Investment Cost}} \right) \times 100\%$$
- - - - Thats Why We Apply discounting Rate Because according To Time Value of Money
        
        the Purchasing Power of The Same Amount is Redused over a Period Of Time.
  - - - If the internal rate of return is used as a discount rate, the net present value is zero.
      - The method of internal rate of return reflects the effective interest rate on an investment.
      - The method of internal rate of return reflects the interest on invested capital.
  - - - Capital Amortization (The Recovery)
        
        it is the Recovery of the Original Investment
        
        To Total Investment Comprises of
        
        Purchase price: EUR 1.0m
        
        Additional fees/taxes: EUR 0.2m
        
        Construction costs: EUR 2.56m
        
        Total Investment: EUR 3.76 million
      - Capital Intrest
        
        it is The Discount Rate
        
        Discount Rate
        
        DiscountFactor = $\frac{1}{(1 + r)^t}$
        
        Reason We Apply
        
        The "Inflation & Risk" Barrier
        
        If you spend 7 million today, you are spending "Full Value" money.
        
        If a project promises to give you 7 million back in 10 years, and you don't discount it, you might think, "Great, I broke even!"
        
        But in 10 years, that 7 million will buy much less than it does today.
        
        By reducing the value (discounting), you are forcing the project to prove it can earn enough to overcome the loss of purchasing power.
        
        By discounting, we "erased" about 3 million from the total.
        
        We did this to ensure that after we pay for the "cost of waiting" (the 10% interest),
        
        we are still actually making a profit.
      - Present Value
        
        Current Cash Flow * Discount Rate
      - Formula
        
        $$NPV = \sum_{t=1}^{n} \frac{C_t}{(1 + r)^t} - C_0$$
        
        Where:
        
        $C_t$ = Cash flow at time $t$ ,
        
        $r$ = Discount rate (10% or 0.10)
        
        $t$ = The time period (year)
        
        $C_0$ = Initial investment (EUR 7 million)
      - Given a calculated interest rate of 10%, what is the net present value
      - of an investment of EUR 7 million for the following payment surpluses (cash flow)
      - for the respective years?
      - Answer
        
        NPV = 3.473 Million
        
        Reasoning
        
        If NPV=0
        
        Capital Amortization: You recovered your full initial investment (the EUR 7 million).
        
        Capital Return: You earned exactly the interest rate you asked for (the 10%)
        
        If NPV= Positive Number
        
        Then You got payed back the initial Investment with 10 % Capital investment Return what you asked For
      - NPV is the surplus left over AFTER the Amortization Period is complete.
      - Tax Shield (Cash Inflow)
        
        If you include a Tax Shield, your Payment Surpluses (like the 1.8m or 0.8m in your images) would actually increase.
        
        Definition: A reduction in taxable income via allowable deductions.
        
        Depreciation Shield: Non-cash expenses (like construction amortization) that save real cash on taxes.
        
        Formula: $Tax Shield = Expense \times Tax Rate$
        
        Impact on NPV: Increases the yearly Payment Surpluses ($C_t$),
        
        making the NPV higher and the Amortization period shorter.
        
        including Tax Sheilds results in a shorter Amortization Period and a higher NPV.