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Net Present Value
and Other
Investment Criteria
Chapter 9

9.2
Learning Objectives of Chapter
Nine
Be able to describe the capital budgeting process
Be able to distinguish between independent and
mutually exclusive projects, and between conventional
(normal) and unconventional (non-normal) project cash
flows
Be able to compute and interpret a project’s net present
value (NPV), and to explain the NPV’s strengths as a
decision tool
Be able to compute and interpret regular payback (PB),
and to explain its usefulness and its shortcomings
Be able to compute and interpret the internal rate of
return (IRR)
Be able to explain the strengths and weaknesses of the
IRR,
Be able to explain why a decision made with the IRR rule
might conflict with a decision made by the NPV rule
Be able to compute and interpret the modified internal
rate of return

9.3
Investment Selection Techniques
Chapter 9 begins a two chapter section on
capital budgeting.
Most of chapter 9 is devoted to examining
and comparing a variety of techniques used
to select from among alternative
investments.
Chapter 10 deals with cash flow estimation
and some special applications of capital
budgeting
We begin by briefly examining the process of
capital budgeting.

9.4
Capital Budgeting
Capital budgeting
– the process that
firms go through to select investments in
long-term assets, such as property,
plant, equipment, and product lines.
•
In capital budgeting, projects are
selected on the basis of their expected
return and perceived risks
The Capital budget
– summarizes the
funding requirements of all the
investments selected by the firm

9.5
Capital Budgeting
Basic Steps in Capital Budgeting:
•
Identify appropriate investment
opportunities
•
Estimate the relevant cash flows
•
Assess the riskiness of the expected cash
flows in order to select an appropriate
discount rate
•
Evaluate the potential investments by
applying one or more capital budgeting
decision techniques
•
Make a decision about which, if any, of the
investments under consideration to select

9.6
Criteria of a Good Capital
Budgeting Method
Primary vs. secondary decision
methods
A primary capital budgeting decision
method (or technique) should meet
the following
four criteria
:
•
Does the technique
consider all relevant
cash flows
?
•
Does the technique
take into account the
time value of money
?
•
Does the technique
consider risk
?
•
Does the technique
indicate whether the

Two Important Distinctions
The following two distinctions are important for
project evaluation:
1)
First,
independent
versus
mutually
exclusive
projects
•
Alternative projects are
independent
if the
selection of one does not affect the decision to
select others
•
Projects are
mutually exclusive
if selecting one
project rules out selecting others.
Projects tend
to be mutually exclusive if they are alternative
ways of doing the same task.
e

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