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Unformatted text preview: 111CHAPTER 11The Basics of Capital BudgetingShould we build thisplant?112What is capital budgeting?Analysis of potential additions to fixed assets.Longterm decisions; involve large expenditures.Very important to firms future.113Steps to capital budgeting1.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.114What is the difference between independent and mutually exclusive projects?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.115What 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.116Net Present Value (NPV)Sum of the PVs of all cash inflows and outflows of a project:=+=Nttt)r 1 (CF NPV 117What is Project Ls NPV?Year CF tPV of CF t 0100 $100 1 10 9.09 2 60 49.59 3 80 60.11 NPVL = $18.79NPVS = $19.98118Solving for NPV:Financial calculator solutionEnter CFs into the calculators CFLO register.CF = 100CF1 = 10CF2 = 60CF3 = 80Enter I/YR = 10, press NPV button to get NPVL = $18.78.119Rationale for the NPV methodNPV= PV of inflows Cost= Net gain in wealthIf projects are independent, accept if the project NPV > 0....
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 Spring '10
 LETSCH

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