Summary Comparison of Various Capital Budgeting Criteria

Summary Comparison of Various Capital Budgeting Criteria -...

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H AAS S CHOOL OF B USINESS U NIVERSITY OF C ALIFORNIA AT B ERKELEY UGBA 103 A VINASH V ERMA A: V ARIOUS C APITAL B UDGETING C RITERIA : A B RIEF C OMPARISON N ET P RESENT V ALUE [NPV] R ULE P AYBACK P ERIOD [PP] R ULE B OOK R ATE OF R ETURN [BRR] R ULE I NTERNAL R ATE OF R ETURN [IRR] R ULE R ULE Accept if 0 NPV ; Between A and B, Choose A if ) ( ) ( B NPV A NPV . Accept if PB “Cutoff Period;” Between A and B, Choose A if ) ( ) ( B PB A PB < . Accept if BRR “Target Return;” Between A and B, Choose A if ) ( ) ( B BRR A BRR Accept if CC IRR [Cost of Capital]; Between A and B, Choose A if ) ( ) ( B IRR A IRR C RITICAL P ARAMETER [Place where information and managerial judgment about the risk characteristics of cash flows are brought to bear upon the decision.] Discount Rate [potentially different for each item in the cash flow stream.] “Cutoff Period” “Target Return” Cost of Capital [CC] [same as Discount Rate for NPV, except that for IRR rule, there is only one CC.] Whether there is an established paradigm for factoring risk in the choice of the critical parameter Yes, the paradigm is called the Capital Asset Pricing Model [CAPM]. No
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This note was uploaded on 04/30/2010 for the course L&S 101 taught by Professor Chow during the Spring '10 term at University of California, Berkeley.

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Summary Comparison of Various Capital Budgeting Criteria -...

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