6-4a.- Capital Budgeting

6-4a.- Capital Budgeting - Ramesh Rao 1 Capital Budgeting...

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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 Set-up 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 Long-term 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 Long-term 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 • Mutual-exclusivity • 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 Economics-based 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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6-4a.- Capital Budgeting - Ramesh Rao 1 Capital Budgeting...

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