06 capital budgeting criteria(1).pptx - Capital budgeting...

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Capital budgeting criteria - 1FNAN 303Financial ManagementCapital budgeting criteria
Capital budgeting criteria - 2Topics CoveredOverview of capital budgetingEvaluating capital budgeting opportunitiesNet present value (NPV)Internal rate of return (IRR)Payback periodDiscounted payback period
Capital budgeting criteria - 3Overview of Capital BudgetingPatriot Theaters owns and operates 145 movie theaters in the Mid-Atlantic RegionThe firm’s managers think that expanding into New England may be a good move for the companyThe managers will conduct capital budgeting analysis to help them decide whether or not to expand
Capital budgeting criteria - 4Overview of Capital BudgetingCapital budgeting is the process whereby a firm decides how it’s going to spend money on projectsThere are many elements to the capital budgeting process such as Identifying potential projectsForecasting the relevant financialsAnalyzing those financialsDeciding whether or not to pursue the projectWe will look at various measures used by firms to make “yes or no” decisions regarding projectsWe assume firms face no constraintsWe assume the relevant period is a year
Capital budgeting criteria - 5Overview of Capital BudgetingProjects involve two types of expected cash flowsInvestment-related expected cash flowsExpected CFs associated with the investment in the projectAlmost always negativeProject-related expected cash flowsExpected cash flows produced by the projectCan be negative, zero, or positive
Capital budgeting criteria - 6Capital Budgeting CriteriaWe will look at the following criteriaNet present value (NPV)Internal rate of return (IRR)PaybackDiscounted paybackEach criterion involves computing a measure for a project and then deciding whether or not to pursue that project based on the numeric value of the measure
Capital budgeting criteria - 7Capital Budgeting Criteria: NPVNet present value (NPV) is a measure that reflects the amount of value a project is expected to createIt is the present value of all expected cash flows relevant for a projectNPV = C0+ [C1/(1+r)1] + [C2/(1+r)2] + … + [Ct/(1+r)t]The appropriate discount rate for all expected cash flows for a project is the project’s cost of capitalNPV rule: accept investments and projects that have positive NPVIf NPV > 0, the project would increase value & wealth, so accept projectIf NPV < 0, the project would decrease value & wealth, so reject projectIf NPV = 0, the project would have no effect on value & wealth, so be indifferent about investing
Capital budgeting criteria - 8Capital Budgeting Criteria:NPV – ExampleWould we accept the finance-tutor project based on its NPV if the project’s cost of capital is 12.0% and its expected cash flows today and in years 1, 2, and 3 are -$1,650, $650, $700, and $900, respectively?

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