Chapter 11

Chapter 11 - 11-1 CHAPTER 11 The Basics of Capital...

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Unformatted text preview: 11-1 CHAPTER 11 The Basics of Capital Budgeting Should we build this plant? 11-2 What is capital budgeting? Analysis of potential additions to fixed assets. Long-term decisions; involve large expenditures. Very important to firm’s future. 11-3 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. 11-4 What 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. 11-5 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. 11-6 Net Present Value (NPV) Sum of the PVs of all cash inflows and outflows of a project: ∑ = + = N t t t ) r 1 ( CF NPV 11-7 What is Project L’s NPV? 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 NPV S = \$19.98 11-8 Solving for NPV: Financial calculator solution Enter CFs into the calculator’s CFLO register. CF = -100 CF 1 = 10 CF 2 = 60 CF 3 = 80 Enter I/YR = 10, press NPV button to get NPV L = \$18.78. 11-9 Rationale for the NPV method NPV = PV of inflows – Cost...
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Chapter 11 - 11-1 CHAPTER 11 The Basics of Capital...

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