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Unformatted text preview: The Basics of Capital Budgeting Chapter 11 O bj1 0 O bj1 0 1 O bj1 0 2 Should we build this plant? 1111 What is capital budgeting? § Analysis of potential additions to fixed assets. § Longterm decisions; involve large expenditures. § Very important to firm’s future. 2112 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. 3113 What is the difference between § Independent projects – if the cash flows of one are unaffected by the acceptance of the other. § Mutually exclusive projects – if the cash flows of one can be adversely impacted by the acceptance of the other. 4114 What is the difference between normal and nonnormal cash flow streams? § Normal cash flow stream – Cost (negative CF) followed by a series of positive cash inflows. One change of signs. § Nonnormal cash flow stream – Two or more changes of signs. Most common: Cost (negative CF), then string of positive CFs, then cost to close project. Nuclear power plant, strip mine, etc. 5115 Net Present Value (NPV) § Sum of the PVs of all cash inflows and outflows of a project: 6116 ∑ = + = N t t t ) r 1 ( CF NPV What is Project L’s NPV? NPVS = $19.98 7117 Year CF t PV of CF t 0 100 $100 1 10 9.09 2 60 49.59 3 80 60.11 NPV L = $ 18.79 Solving for NPV: § Enter CFs into the calculator’s CFLO register. § CF0 = 100 § CF1 = 10 § CF2 = 60 § CF3 = 80 § Enter I/YR = 10, press NPV button to get NPVL = $18.78....
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This note was uploaded on 02/09/2010 for the course BUS 101 taught by Professor Noname during the Spring '10 term at KCTCS.
 Spring '10
 noname
 Fixed Assets

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