School of Sports, Health and Leisure
Diploma in Sports and Leisure Management
S222 Sports Business
Problem 6: Money Not Enough !
6th Presentation
Activity Owner: Allen Goh
Module Chair: Tzu-Yin Kuo
Problem Reviewers: Alex Ong (Dr.)
Hilario Rodrigues
Republic Polytechnic. Copyright 2009.
Today’s problem
You were asked to :
1. Rank Aranda Country Club’s capital investment projects
in terms of profitability
2. Determine if the rates of return for the various projects
cover the cost of capital
3. Determine which project has the shortest payback
period and advise if this is a good way of assessing
investments
Republic Polytechnic. Copyright 2009.
Approach
1. What is the concept of Net Present Value (NPV) ?
2. What are the advantages and disadvantages of the NPV
method?
3. What is the concept of Internal Rate of Return (IRR) ?
4. What are the advantages and disadvantages of the IRR
method?
5. What is the concept of Payback ?
6. What are the advantages and disadvantages of the Payback
method?
7. Back to the problem
Republic Polytechnic. Copyright 2009.
What is the concept of Net Present Value (NPV) ?
NPV=Discounted future cash flows – initial cost of project.
where:
Ct = the net cash receipt at the end of year t
Io = the initial investment outlay
r = the discount rate/the required minimum rate of
return on investment
n = the project/investment's duration in years
Decision Criteria
 If NPV > 0, accept the project
 If NPV < 0, reject the project
Republic Polytechnic. Copyright 2009.
What is the concept of Net Present Value (NPV) ?
Year 0
$
(100)
$
Year 1
Year 2
Year 3
Year 4
Year 5
Year 6
Year 7
Year 8
$ 100
$ 100
$ 100
$ 100
$ 100
$ 100
$ 100
$ 100
90.91
$ 82.64
$ 75.13
$
68.30
$ 62.09
$
56.45
$
51.32
$
46.65
$ 433.49 Net Present Value (NPV) of future cash flow @ 10% discounted rate
For long term investment projects, the cash inflows over the years need to be discounted back to the
present value to assess its actual “net present value”.
What are the advantages and disadvantages of the NPV method
in valuing capital investments?
 Advantages
 Measure cash added from an investment
 Recognize as the best method for investment project
valuation
 Disadvantages
 Estimation of future cash flow is often inaccurate in volatile
business conditions
 Only evaluates quantifiable projects. Projects with negative NPVs
but with strategic value, e.g., Enhance goodwill , R&D etc cannot
be captured.
Republic Polytechnic. Copyright 2009.
What is the concept of Internal Rate of Return (IRR) ?
It is the discount rate when NPV equals 0. It is also the average
annual rate of return received by an company or investor over the
lifetime of their investment.
Decision Criteria
 If IRR > cost of capital, accept the project
 If IRR < cost of capital, reject the project
where:
Ct = the net cash receipt at the end of year t
Io = the initial investment outlay
n = the project/investment's duration in years
r=IRR
Republic Polytechnic. Copyright 2009.
What are the advantages and disadvantages of the IRR method
in valuing capital investments?
 Advantages
 Gives a % rate which is preferred by some business
 Good comparison against the cost of capital
 Information about a project’s “safety margin”
 Disadvantages
 Cannot be used to rank mutually exclusive projects due to the
magnitude and timing of the cash flows.
 Cannot be used to rate projects with alternating positive/negative cash
flow patterns
 Does not account for changing discount rates, so it is inadequate for
long term projects with discount rates that are expected to vary.
Republic Polytechnic. Copyright 2009.
What is the concept of Payback ?
The amount of time it takes to achieve a full return on an investment. Also
commonly known as the “break even” point. Some companies have an
arbitrarily appointed time frame for projects to break even.
Payback = Year before full recovery + Unrecovered cost at the
start of the year/Cash flow during the year
Decision Criteria
 If Payback point is before corporate appointed time frame, accept
the project
 If Payback point is after corporate appointed time frame, reject
the project
Republic Polytechnic. Copyright 2009.
What are the advantages and disadvantages of the
Payback method in valuing capital investments?
 Advantages
 Simple to calculate
 Suitable for short term projects that does not require external
financing
 Suitable for small companies with limited financial expertise
 Focuses on the liquidity position of the company
 Shows the “break even” point clearly
 Disadvantages




Ignores cash flows after the payback
Ignores time value of money
Not accurate in valuing long term projects
Selection of payback period can be too arbitrary
Republic Polytechnic. Copyright 2009.
Back to the problem
Table 1
Undiscounted
total
Payback
NPV
IRR
Jack pot room
$ 296,030
6.396 years
$ 184,254.90
12.60%
Tennis court
$ 265,548
4.068 years
$ 197,560.01
23.56%
Dance studio
$ 170,720
2.187 years
$ 138,071.05
51.55%
Spa
$ 126,460
6.060 years
$ 78,569.27
12.57%
Gym
$ 315,600
4.752 years
$ 229,897.01
22.89%
Republic Polytechnic. Copyright 2009.
Back to the problem
a) By simply looking at the undiscounted total in table 1, we do not take into
consideration effects of inflation on long term revenue.
b) Ranking based on undiscounted profit is wrong. Correct ranking based on
NPV method is 1st gym, 2nd tennis, & 3rd dance studio.
c) Jackpot's IRR is 12.6%.and the spa's IRR of 12.57%. These mean that the net
cash flows are below what is demanded by the shareholders. However, it may
be useful as an attraction to draw membership.
d) The dance studio has the highest safety margin as its IRR of 51.55% is well
above the required12.6%. Tennis court and gym can be retained due to
positive IRR.
e) Dance studio has the fastest payback, but not the highest NPV. The only
projects that payback (break even) less than 5 years are tennis court, dance
studio and gym. But this is an inaccurate method as it ignores effects of
financing interest rates and inflation.
Republic Polytechnic. Copyright 2009.
What have you learnt today?
 Forecast the value of a capital investment project using the
NPV, IRR and Payback methods;
 Interpret the results to make effective decisions
 Understand the strengths and weaknesses of each methods
Republic Polytechnic. Copyright 2009.
Reference
 Gitman, L.(2003). Principles of Managerial Finance. Boston, MA: Addison-Wesley. - Chapter
9.
 Ross, S., Westerfield, R., & Jordan, B.(2010). Fundamentals of Corporate Finance. New York,
NY: McGraw-Hill. - Chapter 9.
 Brigham, E., & Ehrhardt, M. (2010). Financial Management. Florence, KY: South Western
Cengage-Learning. USA. - Chapter 10.
Republic Polytechnic. Copyright 2009.