4.CapBud.NPV

# 4.CapBud.NPV - CAPITAL BUDGETING The Capital budgeting...

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1 CAPITAL BUDGETING The Capital budgeting decision

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2 CAPITAL BUDGETING Criteria to evaluate and choose among alternative investments. A project/investment can be characterized as a series of cash flows: { CF 0 , CF 1 ,..., CF t } Net Present Value (NPV) Definition: NPV = CF 0 + CF 1 (1 + r 1 ) + ... + CF t (1 + r t ) t Example In 2003 Boeing announced plans for the ʻ Dreamliner ʼ - the 787 At an estimated cost per unit of \$150-200M. In 2007, Boeing reported orders for 470 planes .
3 Steps in calculating Net Present Value • Forecast the cash-flows generated by project X over its economic life. • Determine an appropriate opportunity cost of capital that reflects both the time value of money and the risk of the undertaking. • Use this risk-adjusted discount rate to value the cash-flows from project X. The sum of these discounted cash-flows is the project ! s PRESENT VALUE. • Calculate Net Present Value by subtracting the investment necessary for project X from its Present Value. Valuation

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NPV RULE: Invest if NPV> 0 for independent projects. For mutually exclusive projects, take the one with the highest positive NPV. The mechanics of calculating NPVs What to discount : Cash-flows incremental to project decisions. Incremental cash-flow = cash-flow with project – cash flow without project. Cash-flow: difference between money received and money
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4.CapBud.NPV - CAPITAL BUDGETING The Capital budgeting...

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