2019_BM61002_CFI_L04_CB.PDF - Capital Budgeting Decisions A Primer BM61002:Corporate Finance 17 Jan 2019 Prologue • Capital Budgeting An introduction

2019_BM61002_CFI_L04_CB.PDF - Capital Budgeting Decisions A...

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Capital Budgeting Decisions: A Primer BM61002:Corporate Finance 17 Jan. 2019
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Prologue Capital Budgeting:An introduction Capital budgeting decisions Factors to be considered for such decisions Relevant cash flows Effect of texes Depreciation What else? Various techniques of project evaluation Pay Back Period Accounting Rate of Return Net Present Value Internal Rate of Return Profitability Index Modified IRR Which one to go for? NPV vs. IRR: The Battle of the Equals
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Background Time value of money A rupee today is worth more than a rupee tomorrow! Discounting technique: Present value of money Compunding technique: Future value of money Corporate strategic decisions Why do firms invest in projects? Long-term projects vs. short-term projects Project types:Replacements and mutually exclusive projects Capital-intensive decisions, firm’s value, and market’s reactions Accountning terminology Profits Cash flows Depreciation Interest rates Working capital
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1. Capital Budgeting Decisions: Basics and not-so basics!
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Capital Budgeting: An Introduction The process of evaluating and selecting long-term investments that are consistent with the firm’s goal of shareholders’ wealth maximization . Long-term capital expenditure: benefits expected for more than one year (typically!) Strategic in nature Involves huge outlays of funds Not easily reversible Huge costs/impact: financial, operational, and reputational!
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Capital Budgeting: Some examples 1. 2000:Airbus Industrie proposed to develop a super jumbo jet (VLA with seating capacity of 550-990 passengers) with development cost of $13 billion. List price $216 million; competition from Boeing’s 747. 2. 2006:Advanced Micro Devices (AMD)’s decision to invest $2.5 billion to set up chip production facilities in Dresden, Germany, for manufacturing 12-inch silicon wafers (instead of existing 8-inch wafers).Market dominance desired; competition from Intel, Inc. 3. 2009:GoI’s decision to set up UIDAI to issue a unique identification number that can be verified and authenticated in an online, cost-effective manner, for every citizen of India. About Rs. 4,000 Crore spent; 60 crore persons registered. Benefits! Rationale! 4. 20XX: An undergrad’s decision to select a graduate school. Substantial monetary costs (may be not!); Career & life uncertainties; financial, reputational & other rewards.
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Capital Budgeting: Issues and concerns 1. Risk and uncertainties : The future is uncertain! Whole gamut is about forecasting (cashflows, demand, supply, price, risk, etc.) 2. Time value of money : Logically incomparable. Cashflows occur at different time period. 3. Not everything quantifiable : Some intangible benefits.
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