ch11.pdf - Chapter 11 The Basics of Capital Budgeting Overview Net Present Value(NPV Internal Rate of Return(IRR Modified Internal Rate of Return(MIRR

ch11.pdf - Chapter 11 The Basics of Capital Budgeting...

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4/9/2019 1 The Basics of Capital Budgeting Overview Net Present Value (NPV) Internal Rate of Return (IRR) Modified Internal Rate of Return (MIRR) Payback Methods: Regular vs. Discounted Multiple IRRs Chapter 11 11-1 What is capital budgeting? Analysis of potential additions to fixed assets. Long-term decisions; involve large expenditures. Very important to firm’s future. Difficult to predict future demand, which makes forecasting a challenge. Plan too short-term: less forecasting error, but miss long-term trends/opportunities, become uncompetetive Plan too long-term: leading edge, but possibly miss the market / guess wrong, harm current operations by diverting capital away 11-2 Steps to Capital Budgeting 1. Estimate CFs (inflows & outflows). 2. Assess riskiness of CFs. 3. Determine the appropriate cost of capital. 4. Find NPV and/or IRR. 5. Accept if NPV > 0 and/or IRR > WACC. 11-3 1 2 3
4/9/2019 2 Types of Capital Budgeting Projects Replacement: Worn out machines Cost reduction / technology improvement Expansion: Existing products, services or markets New products, services or markets Mergers and Acquisitions Safety/Environmental Other: Office buildings, other real estate, executive perqs 11-4 What is the difference between independent and mutually exclusive projects? What is the difference between normal and nonnormal cash flow streams? 11-6

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