11 The Basics of Capital Budgeting

# 11 The Basics of Capital Budgeting - 11 - 1 CHAPTER 11 The...

This preview shows pages 1–12. Sign up to view the full content.

11 - 1 Should we build this plant? CHAPTER 11 The Basics of Capital Budgeting

This preview has intentionally blurred sections. Sign up to view the full version.

View Full Document
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 1. 2. Assess riskiness of CFs. 3. Determine k = WACC for project. 4. Find NPV and/or IRR. 5. Accept if NPV > 0 and/or IRR > WACC.

This preview has intentionally blurred sections. Sign up to view the full version.

View Full Document
11 - 4 An Example of Mutually Exclusive Projects BRIDGE vs. BOAT to get products across a river.
11 - 5 Normal Cash Flow Project: Cost (negative CF) followed by a series of positive cash inflows. One change of signs. Nonnormal Cash Flow Project: 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.

This preview has intentionally blurred sections. Sign up to view the full version.

View Full Document
11 - 6 Inflow (+) or Outflow (-) in Year 0 1 2 3 4 5 N NN - + + + + + N - + + + + - NN - - - + + + N + + + - - - N - + + - + - NN
11 - 7 What is the payback period? The number of years required to recover a project’s cost, or how long does it take to get the business’s money back?

This preview has intentionally blurred sections. Sign up to view the full version.

View Full Document
11 - 8 Payback for Project L (Long: Most CFs in out years) 10 80 60 0 1 2 3 -100 = CF t Cumulative -100 -90 -30 50 Payback L 2 + 30/80 = 2.375 years 0 100 2.4
11 - 9 Project S (Short: CFs come quickly) 70 20 50 0 1 2 3 -100 CF t Cumulative -100 -30 20 40 Payback S 1 + 30/50 = 1.6 years 100 0 1.6 =

This preview has intentionally blurred sections. Sign up to view the full version.

View Full Document
11 - 10 Strengths of Payback: 1. Provides an indication of a project’s risk and liquidity. 2. Easy to calculate and understand. Weaknesses of Payback: 1. Ignores the TVM. 2. Ignores CFs occurring after the payback period.
10 80 60 0 1 2 3 CF t Cumulative -100 -90.91 -41.32 18.79 Discounted payback 2 + 41.32/60.11 = 2.7 yrs Discounted Payback: Uses discounted rather than raw CFs. PVCF

This preview has intentionally blurred sections. Sign up to view the full version.

View Full Document
This is the end of the preview. Sign up to access the rest of the document.

## This note was uploaded on 04/24/2010 for the course FIN 4414 taught by Professor Staff during the Spring '08 term at University of Florida.

### Page1 / 41

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

This preview shows document pages 1 - 12. Sign up to view the full document.

View Full Document
Ask a homework question - tutors are online