JJ09 - Capital Budgeting Decisions Chapter 9: Capital...

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1 Capital Budgeting Decisions Chapter 9: Capital Budgeting Decisions 1. Capital Budgeting Decisions include the acquisition of long-lived assets. 2. Require that capital (company funds) be expended to acquire additional resources. 3. Also known as Capital Expenditure Decisions . Capital Budgeting Decisions: Examples 1. New retail store outlets. 2. Robotic manufacturing equipment. 3. Digital imaging systems for healthcare facilities. 4. New chairlift for a ski resort. 5. New fleets: ± Ships ± Planes ± Cars 6. New equipment for food preparation.
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2 Approaches ± Net Present Value ± Internal Rate of Return ± Payback ± Accounting Rate of Return The Net Present Value Method 1. Based on the time-value of money. 2. Recall that only incremental cash flows are relevant. 3. Three-step process. The Net Present Value Method: Step 1 ¾ Identify the amount and time period of each cash flow associated with a potential investment. ¾ Note: Investment projects have both cash inflows and cash outflows.
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The Net Present Value Method: Step 2 ¾ Discount the cash flows to their present values using a required rate of return (a.k.a. hurdle rate). ¾ Note: This is the minimum return that management will accept. The Net Present Value Method: Step 3 ¾ Evaluate the net present value--the sum of all of the cash inflows less cash outflows. ¾ Note: if the net present value (NPV) is greater than or equal to zero, the investment should be made. If less than zero, it should not be made. The Net Present Value Method: Example, Step 1 ¾ Identify the amount and time period of each cash flow associated with a potential investment. 1. Initial cash outlay: $70,000 2. Year 1 – 4 net cash savings: $21,000 per year. 3. Year 5 net cash savings: $26,000. 4. Required rate of return: 12%.
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This note was uploaded on 05/12/2010 for the course ACG 5065 taught by Professor Asare during the Spring '08 term at University of Florida.

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JJ09 - Capital Budgeting Decisions Chapter 9: Capital...

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