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Unformatted text preview: Ramesh Rao 1 Capital Budgeting Ramesh Rao 2 Chapter Organization A. Preliminaries B. Six Stages of the Capital Budgeting Process C. Alternative Investment Evaluation Rules D. Basic Setup for a Capital Budgeting Analysis A. Unequal Lives B. Inflation Ramesh Rao 3 A. Preliminaries • Classifying Expenditures: Operating Expenditures Capital Expenditures • What is Capital Budgeting? • Myriad Capital Budgeting Applications Ramesh Rao 4 B1. Establishing Consistency with Longterm goals B2. Screening Phase B3. Evaluation Phase B4. Implementation Phase B5. Control Phase B6. Audit Phase B. “Phases” of the Capital Budgeting Process Ramesh Rao 5 B1. Consistency with Longterm Goals “Strategic” “Economic” Discussion: Ramesh Rao 6 B2. The Screening Phase • What does “screening” mean? • Cost Reduction Proposals • Vertical Revenue Expansion Proposals • Horizontal Revenue Expansion Proposals What are the benefits of screening? Ramesh Rao 7 B3. The Evaluation Phase (cont.) • What is “economic dependence”? • Types of economic dependence: • Complementarities • Substitutes • Independence • Mutualexclusivity • The “Number Crunching” part with evaluation criteria Ramesh Rao 8 B4. The Implementation Phase • Capital Procurement • Administration and Planning Ramesh Rao 9 B5. The Control Phase • Managers must check for: • Deviations from projections • Economic Conditions and Cash Flow Realizations • Benefits of the control phase? Ramesh Rao 10 B6. The Audit Phase • Meaning? • Why? • Practical Significance? Ramesh Rao 11 C. Menu of Evaluation Methods Traditional methods C1. Payback C2. Discounted Payback C3. Accounting Rate of Return Economicsbased methods C4. Internal Rate of Return (IRR) C5. Profitability Index (PI) C6. Net Present Value (NPV) Ramesh Rao 12 C1. Payback Period Criterion • What is payback? • What is the Payback Criterion? Ramesh Rao 13 Disadvantages of Payback • Disadvantages of Payback? • Appeal of Payback? • What about “discounted payback” Ramesh Rao 14 C2. Discounted Payback • How long does it take the project to “pay back” its initial investment taking the time value of money into account? • By the time you have discounted the cash flows, you might as well calculate the NPV. Ramesh Rao 15 C2. Discounted Payback Consider the following project: 1 2 3 $50 $50 $20$100 3 2 ) 1 . 1 ( 20 $ ) 1 . 1 ( 50 $ ) 1 . 1 ( 50 $ 100 $ + + + = flow Cash Discounted Discounted payback for this project is slightly less than 3 years Ramesh Rao 16 C3. Average Accounting Rate of Return • What is the ARR? Investent of Value Book Average Income Net Average AAR = • What is the ARR Rule?...
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 Fall '06
 Hadaway
 Corporate Finance, Net Present Value, Valuation, Internal rate of return, Ramesh Rao

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