Chapter11CapitalBudgetingBasics

Chapter11CapitalBudgetingBasics - OEM 2009 Program The...

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Unformatted text preview: OEM 2009 Program The Basics of Capital Budgeting Page 1 CHAPTER 11 The Basics of Capital Budgeting Capital Budgeting ¡ Capital budgeting is how the firm determines what additions it should make to its fixed assets. ¡ Involves long-term decisions. ¡ Involves large expenditures. ¡ Critical to the survival of the firm. Capital Budgeting Classifications ¡ Replacement z Maintenance z Cost Reduction ¡ Expansion z Existing Product/Markets z New Products/Markets ¡ Safety/Environmental Projects ¡ Other Projects Capital Budgeting Procedures ¡ Estimate cash inflows/outflows. ¡ Assess riskiness of the cash flows and determine r a (WACC on a and determine r a (WACC on a risk-adjusted basis) ¡ Find NPV and/or IRR ¡ Accept if NPV > 0 and/or IRR > WACC Capital Budgeting: Cash Flows Project A Project B Year Cash Flow Cash Flow-$100.00-$100.00 1 $10.00 $50.00 2 $30.00 $60.00 3 $60.00 $30.00 4 $80.00 $20.00 Total $180.00 $160.00 Payback Period ¡ Number of Years to recover the initial cost of the investment: PB Ö $100 = $10 + $30 + $60 PB A Ö $100 = $10 + $30 + $60 PB A = 3 years PB B Ö $100 = $50 + ($60)(5/6) PB B = 1 + 5/6 years = 1.83 years OEM 2009 Program The Basics of Capital Budgeting Page 2 Present Value Payback Proj ect A Proj ect A Proj ect B Proj ect B Year PV at 8% PV Total PV at 8% PV Total 1 $9.26 $9.26 $46.30 $46.30 2 $25.72 $34.98 $51.44 $97.74 3 $47.63 $82.61 $23.81 $121.55 PVPB A = 3.30 years ($17.39/$58.80) PVPB B = 2.09 years ($ 2.26/$23.81) 4 $58.80 $141.41 $14.70 $136.25 Total $141.41 $141.41 $136.25 $136.25 Net Present Value ¡ Present value of inflows minus the present value of outflows (costs)....
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This note was uploaded on 05/12/2010 for the course FIN 5405 taught by Professor Tapley during the Summer '08 term at University of Florida.

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Chapter11CapitalBudgetingBasics - OEM 2009 Program The...

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