Chapter 7 Notes - MGT 326 Ch 7: Net Present Value & Other...

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MGT 326 Ch 7: Net Present Value & Other Investment Criteria 1 Capital Budgeting a Definition : The process of planning and evaluating expenditures on assets whose resulting cash flows are expected to extend beyond one year G Used to decide which projects to adopt G Involves Long-term / Strategic Decisions G Project duration of several years G Errors in forecasting requirements have long lasting effects G Projects in question typically involves large capital expenditures G The larger the firm, the larger the expenditures G Typically involves the purchase of fixed assets (i.e. plant & equipment) that will produce some sort of future cash flow stream G however, the capital budgeting process can be applied to any outflow of cash that produces a series of future cash flows G transportation, automation/MIS, R&D, etc. G costs of market expansion efforts, new product lines, etc. G outsourcing G marketing G Used to evaluate a single project or choose between 2 or more projects G Importance of Capital Budgeting : G Since the results of capital budgeting decisions last many years… G the firm loses some financial flexibility G they are strategic decisions G Erroneous forecasts of requirements can have serious consequences G if too much is invested the firm will incur unnecessarily high depreciation and other expenses G if not enough is invested: G purchased equipment may not be modern enough to enable the firm to be competitive
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MGT 326 Ch 7: Net Present Value & Other Investment Criteria 2 Project (Decision) Types : G Replacement Decisions : whether to purchase capital assets to take the place of existing assets to maintain or improve existing operations. G maintenance of business: replacement of equipment necessary to continue current business operations G cost reduction: includes replacement of serviceable but obsolete equipment with more cost effective equipment G Expansion Decisions : whether to purchase capital projects and add them to existing assets to increase existing operations. G existing products or markets G new products or markets G There is more risk here than in replacement G Safety and/or Environmental Projects G All cash flows are negative G Ex: OSHA G Research & Development G future cash flows very uncertain G the norm is to add very subjective estimates to more “solid” cash flows G Long-term contracts G Other: office buildings, parking lots, executive aircraft, etc. Project Categories: G Independent Projects : Projects whose cash flows are not affected by decisions made about other projects. G Mutually Exclusive Projects : A set of projects where the acceptance of one project means the others cannot be accepted Four Techniques : G Payback Period G Discounted Payback Period G Net Present Value (NPV) G Internal Rate of Return (IRR)
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MGT 326 Ch 7: Net Present Value & Other Investment Criteria 3 Net Present Value (NPV) Method a Definition : The sum of all project cash flows is the Net Present Value G The value of any financial asset is determined by discounting all future cash flows to the present (i.e. find the PV @ t = 0) and
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This note was uploaded on 05/10/2008 for the course FINANCE 328 taught by Professor Cormier during the Spring '08 term at New Mexico.

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Chapter 7 Notes - MGT 326 Ch 7: Net Present Value & Other...

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