# Ch9 - Ch9. The Basic of Capital Budgeting Goal: To...

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Ch9. The Basic of Capital Budgeting Goal: To understand the advantage and disadvantage in different investment analyzing tools Tool: - Net Present Value (NPV) - Payback period - Discounted payback period - Internal Rate of Return (IRR) - Modified Internal Rate of Return (MIRR)

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1. Project classification Replacement Expansion of existing products Expansion into new products or markets Safety and/or environmental projects 2. Types of projects Mutually exclusive project: if one project is taken, the other will be rejected. Independent project: projects’ cash flows are independent of one another
Basic concept in criteria: To find the profitable projects to corporations or investors 3. Net Present Valuation (NPV) - Def of NPV:difference between an investment’s market value and its costs = PV of cash flow from a project – PV of the initial costs and other costs

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- Here, Cost of capitals is used as a discount rate - Rule: acceptable if the NPV > 0. Ex) You want to open a bakery shop. It would generate the profits of \$1000 (1 st year), \$ 2000 (2 nd year), \$3000 (3 rd year). But it would cost \$5000 to set up the store. Is it worthwhile to open the store? (here required rate of return is 10%).
Answer: NPV = -5,000+1000/(1+0.1)+2000/(1+0.1)^2 +3000/(1+0.1)^3 = - 184.07 Therefore, it is not a good investment.

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1) Problem of NPV: - Accurate cash flow? - Discount rate (cost of capitals)? - Market price? 4. Payback rule - Def of payback:the length of time it takes to recover our initial investment.
Rule: acceptable if its calculated payback period is less than pre-specified number of years Ex) Cash flow with the initial costs of \$500. 1

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## This note was uploaded on 02/23/2010 for the course FIN 81341 taught by Professor Yang during the Spring '10 term at CSU San Bernardino.

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Ch9 - Ch9. The Basic of Capital Budgeting Goal: To...

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