FIN5FMA Lecture 3 (Capital budgeting and cash flow estimation)

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Faculty of Business, Economics and LawFINANCIAL MANAGEMENTTopic 3: Capital budgeting andcash flow estimationPresented by:Dr Angela LouLecturer of FinanceDepartment of Economics and Finance, La TrobeBusiness School
Capital budgeting and cash flow estimation3.23.1Define the capital budgeting process, explainthe administrative steps of the process, andoutline the two primary types of capital projectswhich can be evaluated;3.2Describe the major capital budgeting methodsthat are used to evaluate investment projects;3.3Explain the NPV profile, compare and contrastthe NPV and IRR methods when evaluatingmore than one capital project, and describe themultiple-IRR and no-IRR problems that can arisewhen calculating IRR;3.4Outline the formulation of the modified internalrate of return (MIRR) approach to apply as aStudent learning objectives
Capital budgeting and cash flow estimation3.33.5Explain the structure of the three major cashflows that are associated with traditionalinvestment projects, and the major issues anddecisions that need to be considered in relationto cash flow determination3.6Outline the how depreciation charges aredetermined using the modified accelerated costrecovery system (MACRS)3.7Calculate and interpret the results produced fromeach of the following methods when evaluating asingle capital project: net present value (NPV),internal rate of return (IRR), payback period,discounted payback period, and profitabilityindex (PI);Student learning objectives continued
Capital budgeting and cash flow estimation3.4>Capital budgeting refers to the overall process ofplanning expenditure on assets whose cash flowsare expected to extend beyond one year (or belong-term). This overall process can be broken upinto a number of stages:1.Development of a strategic business planSetting the goals and objectives of the firm over the longer-term period (from 5 through to 10-15 years ahead)2.Development of an extensive capital budgetIdentification of potential capital expenditure (capitalproject) options which are consistent with achieving thegoals outlined in the strategic business plan3.Analyzing capital project alternatives to finalize thecapital budgetApply investment evaluation techniques to discriminateIntroduction to the Capital BudgetingProcess
Capital budgeting and cash flow estimation3.5>In terms of financial management decisions, thecapital budgeting process represents the firm’sInvestment DecisionWhat long-term assets (such as equipment, machinery,stand-alone projects and business acquisitions) should thefirm invest in?This is typically considered to be the most important formof decision that the firm has to make, and the one that willgenerate most of the value-creation for the firm>Goal of the investment decision is to undertakecapital expenditure on projects that will maximisethe value of the firmThis is primarily a quantitativeissue, based on maximisingthe dollar value of wealth created for stockholdersIntroduction to the Capital BudgetingProcess continued

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